Week of July 28, 2008--IS THE ECONOMY IMPROVING?

The first ‘advance’ estimate of second quarter economic growth was 1.9 percent while prior quarters’ growth estimates were reduced slightly. The fourth quarter 2007 actually showed a 0.2 percent contraction in growth. So does that mean that we are in fact coming out of a recession? Real estate seems to be bottoming out, at least in some regions of the country.

If so, it is because a tremendous amount of stimulus has been put into the economy, not only by the Federal Reserve. The federal budget deficit is also stimulative. In fact, next year’s projected deficit of $482 billion—due in part to the rebate checks being sent out—is the total annual Gross Domestic Product of Belgium, according to one commentator. This means the government is spending more than it is taking in receipts, hence it is putting more money into the economy.

And more money in circulation should lower interest rates and stimulate businesses. Too much money in circulation also stimulates inflation, however, hence the tightrope the Federal Reserve is walking between its twin mandates of maintaining long term growth with low inflation.

The increasing unemployment rate—it rose from 5.5 to 5.7 percent in July—may belie any relief, but that is because more workers were kept on the unemployment rolls. Congress extended unemployment benefits for another 13 weeks, which has caused consumer confidence to increase in both the Conference Board and University of Michigan surveys.

The new housing bill may also provide some relief, though housing only accounts for 7 percent of economic activity. The conforming limits for loans insured by Fannie Mae and Freddie Mac that were boosted to $729,750 for a single unit this year, but will be permanently reduced to $625,500 as of January 2008. A $7,500 temporary tax credit for first time homebuyers should also help, given the fact that first-timers now make up 40 percent of homebuyers, according to the National Association of Realtors.

And the housing sector is beginning to work off excess inventories with new-home inventories back down to a 10-month supply, even though prices continue to decline. The good news is that some regions are showing price increases, after falling a cumulative 15.8 percent since last fall, according to the latest S&P Case/Shiller price index. Its survey showed that existing-home prices had actually risen in seven major metropolitan areas—but none yet in California.

Even the higher unemployment rate held some good news. The past 2 months showed 26,000 more jobs were created than originally estimated. And a major reason for the jobless increase was the temporary flood of summer youth 16-25 years old into the job market, with fewer able to find work. So the jobless rate could stabilize in the fall. The real estate bust has caused problems with our financial institutions that had over expanded into residential loans. Financial sector activity in general—including the activities of hedge funds, pension funds and the like—had ballooned to more than 25 percent of domestic (GDP) economic activity. It is now shrinking back to a more sustainable size. This will take time.

© Harlan Green 2008