IS THERE LIGHT AT END OF THE TUNNEL?

The economic news is not all dire, though financial markets don’t yet seem to get it. Remember, headlines only capture most economic events after the fact. Though the recession began in December 2007, for instance, it wasn’t until June of 2008 that bad news began to appear in the headlines. And the recession wasn’t made ‘official’ until November 2008, when the NBER’s Business Cycle Dating Committee was sure economic activity had in fact topped out the prior December.

For the same reason, very few media are focusing on the often subtle turning points that signal when economic activity has bottomed out. This recession began only after the Federal Reserve had boosted interest rates 17 consecutive times in an attempt to combat inflation. But instead of driving down its cause—high energy and commodity prices—the Fed’s actions drove up mortgage rates on short-term Option and subprime ARMs, which made those loans no longer affordable to the marginal borrower.

The result is people are saving more and buying less. But existing real estate sales surged 6.5 percent in December, as housing prices have come back down to affordable levels. This is due to a combination of lower interest rates and the largest median price decline in 70 years, according to the National Association of Realtors. In fact, the NAR’s Affordability Index has increased more than 50 percent since 2006, meaning buyers can afford a house worth 50 percent more than the existing-home median price of $174,000.

Both the manufacturing and service sectors are also showing signs of improvement. January new orders surged 10 percent in manufacturing and 3 percent in service sector industries, according to the Institute for Supply Management. Retail sales also jumped 1 percent in January, the largest increase in 1 year.

And labor productivity is surging, because employers cut back working hours faster than they cut back on production. The resulting output per hour worked increased a large 3.2 percent in Q4, and for the year rose at the fastest pace since 2003.

Why is this good for future growth? Because high productivity growth means the economy can grow rapidly without inflation, raising living standards and theoretically allowing workers to get big raises without hurting company profits. It means companies will invest more in so-called capital expenditures that help to maintain that productivity. But it also means fewer workers will be needed as companies become more efficient in producing those goods and services.

We can also debunk one more piece of conventional wisdom. It doesn’t look like inflation will be a problem for years to come, in spite of the $2.5 billion in stimulus aid that is being injected into the economy. The Congressional Budget Office has predicted that the shortfall in output over the next 2 plus years will probably be around $6 billion, and an economy working at less than capacity does not induce inflation.

Harlan Green © 2009