THIS RECOVERY FEELS MORE LIKE PURGATORY THAN PARADISE
Pick a consumer indicator, any consumer indicator. Chances are, its performance is lagging far behind the typical pace for a recovery. That's true for jobs, income, confidence, borrowing, spending--you name it. Because consumers buy two-thirds of gross domestic product, it's easy to see why this economic recovery seems more like economic purgatory.
To put the problem simply: Household finances are a wreck. The process of fixing them is painfully slow because financial resources are so strained. Excluding the government dole, inflation-adjusted personal income is not growing (chart). Consumers dare not dip into their already skimpy savings. And for households with heavy existing debts, more borrowing is out of the question--even with interest rates at 20-year lows.
The balance-sheet sins of the 1980s would take time to purge even in a peppier recovery. But no growth in private-sector payrolls and the slowest pace of hourly pay in 412 years have left consumers without the income gains needed to get back on their feet. And that won't change until the labor markets start to generate more jobs.
One glimmer of hope on the job front: Initial claims for jobless benefits fell in the week ended Aug. 15 to an annual rate of 382,000--the fewest in nearly two years. If claims continue to run below 400,000 per week, they would be signaling at least a slight improvement in labor-market conditions.
For now, though, consumers are just not financially able to spark a healthy recovery. Judging by the initial readings for August, that inability continues to hold back huge sectors of the economy, including autos, housing, and manufacturing generally.
The latest numbers on personal income show why consumers are hurting. Earnings from all sources rose a modest 0.2% in July. Adjusting for inflation, real personal income is up a scant 1.6% from a year ago. Clearly, that pace will not support much of a gain in spending.
However, the performance of personal income is really worse than that. Excluding transfer payments such as Social Security, medicare, and unemployment insurance, real personal income has not grown at all. Government payouts have accounted for all of the advance in real income from a year ago, while earnings from wages, rents, dividends, and interest have languished.
Rental income in September will take a big hit from Hurricane Andrew, as it did in 1989 after Hugo. Andrew will also cause temporary fluctuations in such indicators as jobless claims and commodity prices, but its impact on the broader measures of economic performance, such as gross domestic product, will be negligible.
In terms of lost income, falling interest during the past year and a half has blown its own ill wind over Florida and the rest of the nation as well. Since hitting a record in December, 1990, interest income has dropped by some $35 billion--the steepest slide in the postwar era. Interest accounts for more than 13% of personal income, and many retirees have been hit hard. In the aggregate, interest income lost because of lower rates largely offsets the extra buying power that consumers are getting by refinancing their debts at lower rates.
To be sure, many households are doing penance for their financial sins, but manufacturers and builders are suffering as well. True, corporate profits look a lot better. But weak consumer demand has kept companies from moving ahead on production increases, new capital projects, and inventory building. Until spending shows more life, production will continue to move sideways, and future growth in profits will be at risk.
One of the reasons that personal income isn't growing is the dichotomy between sagging household earnings and rising corporate profits. Despite weak demand, companies are lifting profits by cutting costs--a euphemism for eliminating jobs.
Before-tax operating profits of U.S. corporations rose 1.7% in the second quarter, to $390.9 billion, according to the Commerce Dept. The gain followed a 10.6% jump in the first quarter, and earnings are up 12.5% from a year ago--the first double-digit annual rise in 312 years.
A key factor in this success: Companies are lifting their profit margins, because unit labor costs have slowed even more than prices. Margins of nonfinancial companies have risen for three consecutive quarters (chart). Last quarter, they were the highest in two years.
But in spite of healthier profits, slack business conditions remained the norm in August. The National Association of Purchasing Management's index of industrial activity slipped to 53.7% last month, from 54.2% in July (chart). The reading suggests that the manufacturing sector is growing, but at a negligible pace.
That was also the message from the government's July data on manufacturing. Factory orders slipped 1.1%. Durable goods orders dropped by 3.2%, worse than the 2.3% decline originally reported. Factory inventories remained very lean. They were flat in July, and a 0.4% rise in shipments pushed the ratio of stock levels to sales down to a 13-year low.
The strike at General Motors Corp. is likely to show up in the factory data for September (page 28). If the affected plants reopen by the second week in September, gm will lose only about 5% of its September car production and about 4% of its truck output, according to Ward's Communications in Detroit. But unless the strike is protracted, its drag on the economy will be small.
Manufacturers aren't the only ones suffering, though. Builders are also having a tough time. Construction spending fell 0.6% in July, on top of a 0.4% decline in June. Builders are sure to get some help when Florida and Louisiana rebuild from Hurricane Andrew. But the effect will be spread out over many months.
For builders elsewhere, lower mortgage rates and better job growth are the tonics needed for a faster pace of business. The housing recovery hit a plateau in the spring, but the steep decline in mortgage rates in July and August suggests that the sector may be reviving.
In July, sales of new single-family homes dropped 2.6%, to an annual rate of 563,000. But mortgage rates started to fall in July. They hit a 19-year low of 7.95% by mid-August, touching off a spurt of mortgage applications for home purchase. That means home sales should register healthy gains, probably in August and September. And increased spending on residential construction should add to economic growth in the third quarter.
But that doesn't mean the economy will expand rapidly. The government's index of 11 leading indicators, which foreshadow future growth, rose a slim 0.1% in July, after falling 0.3% in June (chart). The biggest decliners in July--unfilled factory orders, changes in materials prices, and contracts for plant and equipment--all underscore the softness in demand in the third quarter.
In fact, domestic spending was weaker last quarter than was first thought. The Commerce Dept.'s revisions to the real gross domestic product confirmed that the economy grew at an anemic 1.4% annual rate in the second quarter. But final demand was weaker, falling at a 0.4% pace, instead of the 0.3% rise originally reported.
Inventories, especially in wholesale and retail trade, offset that weakness. They grew much faster than first thought, as did imports. That mix suggests that much of the inventory rise last quarter came from imports, not from domestic production. That means the inventory spurt will not cause U.S. factories to cut output.
Still, manufacturers will not gear up production until consumers get back on their feet. To regain their balance, many households are abstaining from debt and excessive spending. That will shore up balance sheets and improve the savings rate. But the hair shirt of feeble demand will only drag out this economy's suffering.JAMES C. COOPER AND KATHLEEN MADIGAN