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Our Economy Today - April 2009

So, where do we stand as of April 2009?  What is the condition of our economy?  Federal Reserve Bank just released its “Beige Book” which is a summary/survey of current economic conditions across the Fed’s 12 districts .  This report is published eight times per year.  But sometimes it needs interpretation because of the “economicese” or Wall Street speak.  The Beige Book is an assessment of current economic conditions and not a forecast or projection of our future economic conditions.  We have to look else where for a forecast.  The forecast depends on many factors which I will briefly cover.  Economics is certainly not an exact science. 

Here is the first paragraph of the Summary of the Beige Book:

Reports from the Federal Reserve Banks indicate that overall economic activity contracted further or remained weak. However, five of the twelve Districts noted a moderation in the pace of decline, and several saw signs that activity in some sectors was stabilizing at a low level.

Translation: the economy is bad but not as bad as it was a few months ago.  Our economy may be bottoming out but that doesn’t necessarily mean we are recovering.

Employment or labor market is still very weak.

Labor market conditions were weak and reports of layoffs, reductions in work hours, temporary factory shutdowns, branch closures and hiring freezes remained widespread across Districts.

If we are not working that probably means that we are not spending.  The reality is consumer spending drives our economy.

Consumer spending remained generally weak. However, several Districts said sales rose slightly or declines moderated compared with the previous survey period. In particular, the Boston, Cleveland, and Chicago Districts reported an improvement in sales. Purchases of big ticket and luxury items continued to decline while spending on food and necessities fared better. The Philadelphia, Dallas, and San Francisco Districts reported that consumers were looking for value, and were opting for lower-priced, private label products over higher-priced alternatives. Retailers kept inventories lean, in line with the slow pace of sales, and most expect demand to stay at current low levels over the next few months.

What was troubling for me was the report on commercial real estate:

Nonresidential real estate conditions continued to deteriorate over the past six weeks. Demand for office, industrial and retail space continued to fall, and there were reports of increases in sublease space. Rental concessions were rising. Property values moved lower as reality “set in.” Construction activity continues to slow, and several Districts noted increased postponement of both private and public projects. Nonresidential construction is expected to decline through year-end, although there were some hopeful reports that the stimulus package may lead to some improvement.

Commercial real estate investment activity weakened further. Contacts said a decline in credit availability and markdowns on commercial property were keeping buyers and sellers on the sidelines.

Banks, particularly financial conglomerates like Citigroup and Bank of America, have mortgage loans (sometimes very large loans) on commercial real estate and if those mortgage loans go bad or stop “performing” that will only make the bank bailout situation even more costly to taxpayers.

Prices on goods and services were holding steady and lower except oil prices (more on that in a minute):

Districts that report on prices noted downward pressures. Oil prices rose during the survey period, although most other commodity prices were stable to down. Manufacturers noted declines in the cost of raw materials and inputs, and product prices were generally said to be steady to down. Significant discounting was reported among retailers, and there were numerous examples of service providers reducing fees. In particular, accounting and legal firms in the Dallas District were responding to customer requests for lower fees, while the San Francisco District found prices were declining for professional services and lodging. Transportation service contacts noted a reduction in prices.

In my opinion, there are two things that are keeping us from deeper problems and yes possibly a depression: 1) people who are still employed (employment rate= approx. 90%) and 2) government spending.  There are signs of life that we can possibly build on such as very slight increase in sales in some areas and that the decline in economic growth is not as fast as it was a couple of months ago.  Our economy is in a very fragile state right now - any one factor such as an increase in oil prices (definitely $100 per barrel) and a worsening of the financial/banking crisis can tip us into a more serious situation.

Where are we heading?  What is our economic outlook? Obviously this my humble opinion as a finance guy.  I agree with this outlook from Baseline Scenario.  To summarize:

On balance, we believe that the Obama administration, and Fed Chairman Bernanke, are making every effort to combat the financial and economic crisis. However, some aspects of the response, most notably the fiscal stimulus, have been underpowered. And a combination of ideological and political constraints has hampered the administration’s efforts to rescue the banking system. For these reasons, we still do not see the mechanism that will cause the economy to turn around.

In this context, we interpret the recent stock market rally as indicating that the economic decline is slowing; it does not necessarily denote that rapid recovery is just around the corner.  We would also emphasize that credit markets are pricing in a substantial risk of default for some leading brand names, both in financial services and manufacturing - as the system stabilizes and bailouts become harder to justify, the probability of default for large companies may continue to rise.

I do believe we will see higher “official” unemployment and the banking situation may get worse because of the commercial real estate market.  Obviously, oil prices will also be a major factor in our economic recovery - if oil prices start increasing (greater than $70 per barrel) or spiking ($100 per barrel) recovery will be nearly impossible.  Bottom line, in my opinion, is that we don’t start improving until late 2010.  Unfortunately, I do expect that we will experience much more pain particularly with unemployment.  Sorry for the bad news.

Good luck.

UPDATE:

I am including an image that explains economic cycles.  Click on image to enlarge.

Source: Wikipedia

The Fed, in the Beige Book, is saying we are at the end of the contraction period possibly heading into the trough.  We will see.

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