Economic recoveries usually get their biggest kick from a rebound in the most cyclical parts of the economy. Consumer spending on big-ticket items tends to increase as worries about job security subside, hiring increases and income and household wealth rise. Once consumers are back on their feet, homebuilding (and associated landscaping) and business fixed investment typically ramp back up and inventories rise in line with the higher level of economic activity.
Spending And Investment Are Increasing
We now see the key cyclical drivers of economic activity kicking into a slightly higher gear. Spending for big ticket items appears to have caught a tailwind from the gradual improvement in the job market, the rise in home prices, and the booming stock market. Business fixed investment also appears to be on a sturdier foundation, led by strong private sector demand, a booming energy sector and somewhat-stabilizing global economy. Finally, homebuilding appears to be well on its way to a self-reinforcing recovery.
The year began amid a great deal of angst about the fiscal cliff and the federal budget sequestration. Now that both events have passed, confidence is increasing that economic growth will find a way through the clouds hanging over fiscal policy. Even the puny 0.1 percentage point rise in fourth quarter 2012 real GDP growth was not too much cause for concern. Most of the quarter’s weakness was due to a 22 percent plunge in defense spending, which was at least partially tied to preparations for the impending sequestration.
Consumers appear to have also shrugged off much of Washington’s latest shenanigans. Even the expiration of the two-percentage point payroll tax holiday appears to have elicited little initial response, though time will reveal the longer-term effect. Consumer spending through the first two months of 2013 has held up relatively well, even with the added burden of sharply higher gasoline prices.
Commercial Construction Shows Positive Movement
On a different note, according to the American Institute of Architects, the Architectural Billings index has been positive for seven consecutive months now and suggests some increase in commercial real estate investment in the second half of 2013. (There is an approximate nine- to twelve-month lag time between architecture billings and construction spending on non-residential construction.) Every building sector is expanding and new project inquiries are strongly positive — the highest since January 2007. This includes commercial and industrial facilities like hotels and office buildings, multi-family residential, schools, hospitals and other institutions.
That is good news for the green industry since a whole lot of flowers, shrubs and trees (and subsequent landscape maintenance services) will be potentially needed for those construction projects.
Rise In Stock Market Still Not Matched With Jobs And Salaries
However, the relentless march of the equity markets has raised concerns as to whether monetary policy is fueling another bubble. But folks should not overestimate the importance of the stock market reaching a new high, because it hasn’t been matched by a similar increase in incomes and job prospects. The Dow may be back to its old highs, but there is still nearly a $1 trillion gap between what the economy is capable of producing and what it’s actually producing. The unemployment rate is hovering around eight percent, and the average earnings in the private sector, adjusted for inflation, have barely budged for five years.
Interestingly, the main driver for the recent stock market bolstering has been the monetary policies of the Federal Reserve Bank. Currently, the Fed’s quantitative easing (QE) policies are pushing an extra $85 billion per month into the financial system, on top of about $2 trillion from its previous stimulus-related efforts. It is buying a mix of Treasury bonds (which help lower U.S. government borrowing costs) and mortgage-backed securities (which help lower mortgage rates).
A key operating theory at the Fed of how these help growth is known as the “portfolio balance channel.” The Fed buys securities. The investors who otherwise would have bought those bonds have to invest in something else. Maybe it’s corporate debt, maybe it’s the stock market, but either way it props up private asset prices and makes it cheaper and more desirable for companies to invest. Higher prices for stocks and other assets also have “wealth effects,” making the people who own those securities feel richer and therefore more willing to spend. It is no coincidence that the rally in the stock market this spring has come about following speeches by Fed officials suggesting that QE policies aren’t going away anytime soon.
This isn’t the Fed’s fault; they’re just trying to use the tools they have to get enough growth to bring down unemployment, and it just happens that the tools they have work through channels that favor those with lots of financial assets. It would be within the power of Congress to do something to ensure those policies benefit the masses. It even had one such policy in place until a couple of months ago: the payroll tax holiday, in which the government, with its ultra-low borrowing costs courtesy of the Fed, increased Americans’ after-tax paycheck by two percent. We knew that it was going to have to go away eventually to keep the finances of Social Security sustainable, but in fiscal cliff negotiations at the end of the year, there was no strong push to replace it with any other policies to try to pump money into the hands of ordinary Americans.
The Fed has basically one tool to affect the economy: It decides whether to make money cheaper or more expensive. As long as the central bank is the only entity in Washington doing anything to try to strengthen growth, no one should be surprised if Wall Street keeps rallying and the real economy is slow to keep up. GG