Business Journal

Where Is the Economy Going?

Confused by all of the mixed signals? Gallup's chief economist, an early forecaster of the downturn, tries to clear things up.

Everyone is anxious to know which way the economy is heading. On one hand, the U.S. GDP contracted more sharply than expected in the first quarter, but much of the U.S. government's stimulus spending has yet to kick in. The U.S. economy shed 563,000 jobs in April while unemployment rose to 8.9%, and economists -- including Federal Reserve Chairman Ben Bernanke -- expect job losses to continue in coming months.

The consensus among economists and Wall Street observers seems to be that the economic freefall is over, and now the rate of decline is slowing.

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But there's also reason to believe the economy may be bottoming out. In Bernanke's testimony to Congress on May 5, he noted that consumer spending, which dropped in the fourth quarter of 2008, is up in recent months; sales of new and existing homes also appear to be stabilizing. Gallup's economic indexes show a modest uptick in consumer mood, although consumers are still keeping a tight hold on their wallets. (See "Weekly Economic Wrap: Hiring Up, Spending Still Down" in the "See Also" area on this page.)

We're in the midst of a nerve-wracking period of conflicting information with seemingly endless potentialities and variables. Following any direction without careful thought offers sharp consequences to business leaders and managers. Right now, many executives' most pressing questions are: Has the economy reached an inflection point and begun moving in a positive direction? And if not now, when will it?

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Perhaps more importantly, the most forward-looking among us really want to know what will happen a year or two after that tipping point has been reached. Will the recession have been so painful that U.S. consumers will have changed their profligate ways? Or are they just waiting for things to stabilize before they start throwing money around again?

Gallup Chief Economist Dennis Jacobe, Ph.D., has many insights into where the economy is going -- and why. Dr. Jacobe was one of the earliest forecasters of the downturn: In June 2007, he warned us what could befall the economy if the housing market didn't right itself, and in February 2008, he noted that the U.S. economy was slipping into recession -- a reality that official recession watchers at the National Bureau of Economic Research later confirmed, stating the U.S. recession began in December 2007. (See "The Subprime Meltdown Will Burn Everyone" and "Is the U.S. in a Recession?" in the "See Also" area on this page.)

Dr. Jacobe is not much more cheerful about the economy now, but he's sure of a few things. Among them, as he notes in this interview, is that job creation is not a trailing indicator as is commonly thought, and the economy won't improve as long as a significant percentage of the working population is unemployed. What's more, the financial system has been devastated by this recession, and this will force consumers to be more prudent and rational whether they want to be or not. That, says Dr. Jacobe, is no fun. But once that adjustment is made, our economy will begin growing once again.

GMJ: In the first quarter of 2009, GDP was down 6.1 percent, a sharper decline than had been expected.

Dr. Jacobe: Yes. There was more inventory decline than many anticipated. The economy was weaker in the first quarter, businesses were liquidating their inventories faster than people had anticipated, and government stimulus spending hadn't kicked in yet. That 6.1 percent is also a preliminary number, so it can be revised. When the economy is contracting anywhere near 4% to 6%, though, that's a significant decline, and it has major implications for things like the job market.

The consensus among economists and Wall Street observers seems to be that the economic freefall of late 2008 and the beginning of 2009 is over, and now the rate of decline is slowing. The real issue is whether what appeared in April and May to be an approach toward leveling off will continue or whether there's another drop yet to come. We don't know yet.

GMJ: What are the implications for the job market?

Dr. Jacobe: Continued job loss at a very fast pace. The U.S. is losing more than 500,000 jobs a month, and I hope that won't go on much longer, because that's just an enormous rate of job loss. We can get inured to the idea that we're losing massive numbers of jobs a month, and then we celebrate if we lose less than 500,000 in a month. That's a real demonstration of how we can adjust our perceptions to a new reality, but it's a terrible loss rate in terms of jobs -- and how losing jobs affects peoples' lives. If that continues for a year, the U.S. will lose more than 6 million jobs.

We really need to see more stability in the job market, more job creation, and a real increase in consumer spending before we'll get any real recovery.

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GMJ: Do you think the second quarter will be better?

Dr. Jacobe: I think the general view among economists is that the second quarter will be better. It's really a matter of defining what "better" is. Will the rate of deterioration moderate? It probably will. But, I would hope that in the second half of 2009 the economy will bottom out, and then begin to show some real improvement next year. And I think it will. The questions are, how much further down will it go before reaching bottom, and what kind of recovery will we have?

GMJ: Six to eight months ago, many economists were saying the economy would reach its nadir in summer 2009, then it would start to grow again -- or at least stop contracting so fast. Do you think that's likely?

Dr. Jacobe: It's a matter of perspective. I think most economists were saying that the second half is when we'd start to see a recovery. Then things got worse, so that got modified. Now, most economists think the economy will bottom out in the second half of 2009 and begin recovery in 2010. I think given the current situation, that is the most likely scenario.

But there are several reasons for concern. First, the current economic downturn started as a financial crisis led to a crisis for the overall economy. Although the financial situation seems to be improving, I'm still concerned about the flow of credit to consumers and small businesses. The evaporation of the so-called shadow banking system of securitization, increased bank capital requirements, a return to old-time underwriting standards, and increased credit losses in such sectors as commercial real estate and credit cards all suggest reduced credit availability compared to anything experienced during the past several years.

Second, we are in a period of business uncertainty unparalleled since the 1930s. Business owners and managers simply have little or no "visibility" going forward. Consumers have changed their spending habits and businesses have stopped investing. Further, there appears to be a level of "government risk" that is unprecedented in the post WWII period. This may be the right time -- even a golden opportunity -- for achieving "change" in many major business sectors politically, but the resulting increased uncertainty could "metastasize" the current recession.

Third, now we're in a more traditional recession. As more businesses disappear and unemployment goes up even more, there could be another pullback in spending by consumers and businesses. As you can tell, right now I'm really worried about consumer spending. In this regard, most people think of the job market as a lagging indicator, but I think employment is the key to rebuilding the consumer psychology that allows consumers to spend comfortably and on big-ticket items. I think people need to feel more secure about their jobs -- and they need to feel more secure about their personal balance sheets -- before we'll see a real upswing in the general economy.

What we really need to see is more stability in the job market, more job creation, and a real increase in consumer spending before we'll get any real recovery.

GMJ: What will it take to bring back jobs?

Dr. Jacobe: The stimulus program was designed so that it won't really have a big impact this year, but it will help next year. Government spending will pick up throughout 2009 and will accelerate into 2010. Of course, the real question will be, will consumers and businesses start spending again?

At some point, inventories and employment will get in line with the new spending rate, and the economy will start to improve -- but first, people need to get to a level of spending where they are comfortable with their personal balance sheets and job outlook. Then, as the job outlook improves and as personal finances become stronger, consumer spending will increase. That will stimulate new job creation, and it will become a positive upward cycle; it will be the reverse of what we've gone through on the downside -- but unfortunately, improvement is likely to take place at a much slower pace than the recent downward spiral.

GMJ: People are talking about "the new austerity," suggesting that Americans have fundamentally changed their outlook on consumption. Is that true? Are American consumers really smarter with money now, or are they just waiting out this bad patch before they start spending again?

The bottom line is, I don't think people will revert to old patterns. We'll see more saving and more careful investing in the future.

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Dr. Jacobe: U.S. consumers aren't going back to where they were before the recession. That economy of the past several years was based on a bubble, and everybody enjoyed living in the bubble, but it had to end at some point. A key difference is that credit won't be available like it was previously. Even if consumers wanted to go back to their free-spending and borrowing ways, the financial system has undergone a major shock, one that will be felt for a long time.

Many people in the U.S. have received a major financial shock that they never expected or experienced before. They'll have trouble borrowing even if they wanted to, because credit is much harder to get. People who thought that they would use the equity in their homes to send their kids to college -- that equity has disappeared. Only people who have extremely good credit -- and who least need the money -- will have easy access to credit for some time to come.

A percentage of the population also got so burned by recent events that they just can't go back to their old consumption patterns because they must rebuild their personal balance sheets. People have lost value in their homes and their investments. Others have decided that they must return to "old-fashioned" personal finance patterns to improve their savings and investing.

In this regard, I think it's also true that consumer psychology will change. I think there will be social pressure to conform to a more frugal lifestyle. The Gallup Poll asked Americans about their spending habits, and one-third of consumers said that spending less is their "new normal" pattern of behavior. (See "In U.S., 32% Say Spending Less Is Their 'New Normal.'")

The bottom line is, I don't think people will revert to old patterns. We'll see more saving and more careful investing in the future.

GMJ: That's an optimistic view. A few years from now when everything's OK again, what's to stop the credit markets from opening up and letting people borrow freely again, sending the economy into a new bubble or tailspin?

Dr. Jacobe: The reality is that much of the world's financial system actually dissolved last year. Companies that people never thought could fail, in essence, have collapsed, and that changes the perception of the people who run those companies at numerous levels of management. During the Great Depression, things were so bad and people saw such huge financial losses that they adopted a new perspective toward risk and savings that lasted for generations.

These days, the people who had planned to retire or did retire saw a lot of their money disappear, and they're more cautious. So are the people who were running financial institutions and manufacturing companies who saw that they could be going out of business. The banking regulators, too, have been so badly burned that they and Congress just won't let the kinds of lending that went on before happen again. So I think it is going to be a long time before so many people will be allowed to take so much risk without anyone really understanding what is happening.

GMJ: Will this mean more regulation?

Dr. Jacobe: What usually happens in this kind of cycle is that there's a major effort to simplify things: If you don't understand it, then you don't do it. In the financial markets, many of the financial vehicles became so complex that both the people using them and the people regulating them didn't really understand the risks they posed not only to individual companies but to the financial system as a whole. I don't think government or the regulators will take on those kinds of risks blindly again. History suggests that we are headed for a period of much greater regulation -- most likely "over-regulation." It will take awhile before anyone feels secure enough to support significant financial deregulation again.

GMJ: So in that case, will the economy ever grow again?

Dr. Jacobe: Oh yes. The U.S. economy is the greatest economic growth engine ever devised. It just won't be the kind of rapid growth that we've seen in recent times. We won't have the boom times that we had prior to the current debacle, but we'll have good solid growth built on increased productivity, new job creation, and human capital optimization.

In fact, if you look back at this interview five years from now, I'll bet you'll wonder how you could have asked that question. On the other hand, between now and then, there are likely to be a great chorus of others asking that same question loudly and often.

-- Interviewed by Jennifer Robison

Gallup http://www.gallup.com/businessjournal/118549/Economy-Going.aspx Gallup World Headquarters, 901 F Street, Washington, D.C., 20001, U.S.A +1 202.715.3030