US Economic Recoveryon Thursday, 26 May 2011. Posted in Economic Commentary
Why the US is about to rebound
Currently the United States economy is in recovery mode, having added an average of about 250,000 jobs per month for the last 3 months, the trend is clear – see an article on the economist magazine which covers this topic.
This is not to say that the US economy is presently completely healthy. Problems clearly remain. Unemployment remains too high, housing prices are soft and drifting lower, the housing construction industry remains very weak with record low housing starts being recorded. Non-core inflation remains too high due to rising energy and food prices and it is these negative areas the media is concentrating on, not the positive trend in unemployment – and it is unemployment that is the source of most problems.
Business has Lots of Cash on Balance Sheets
To be sure, the reduction in unemployment from 9.7 to 8.7 is not enough, but it is the start of a positive and self re-enforcing cycle in economic growth as businesses finally start to invest after building big cash piles on their balance sheet. The two big brakes on the US economy at present are consumer spending (due to house prices and unemployment) and business investment (which affects unemployment also) as both sectors focused on paying down debt and getting on a solid financial platform after years of overspending. The recovery in consumer balance sheets is likely to continue for some time, but the recovery in business balance sheets is mostly over, and a huge cash pile has been created. Standard and Poors estimates that in Q4 2010, just the Top 500 had more than $837 billion in Cash on their balance sheet which is 26% higher than 12 months previously. Credit Suisse estimates that this is just the tip of the iceberg with more than $2 trillion in offshore subsidiaries alone, again, just for the Top 500 which is the widest group of companies for which statistics seem available.
Business Investment still postponed, but Capacity Utilization creeping up
Business, having gone through the credit crunch of 2007 and 2008, have now over-built their cash fortress and face a choice, given interest returns are presently so low and most debt has been paid down. The can a) invest in new businesses such as factories, b) return the money as dividends or c) launch takeovers. Our bet is all three will rise, but the surprise will be business investment which has remained low, but will recommence due to falling spare capacity.
Capacity Utilization close to average (finally)
Capacity Utilization, as measured by the US Federal Reserve is currently at about 77% and trending up. For comparison, the average is about 80.4% (1972-2010) and the low in 2008-09 was 67.3% a full 10% below present levels. Historical high points are about 85%, so in summary we are presently very close to average capacity use and should get there in the next few months. This is the usual point of sustained business investment – the process that creates significant amounts of jobs. And it is jobs, or the lack of them, that is keeping the economy constrained and economy weak so far. Once that final domino falls (business investment), then the recovery will commence in earnest and even stronger growth in employment should be expected.
Weak US dollar
Many people measure the US dollar versus a particular currency, say Euro, Sterling or Yen, but the proper economic way is of course an index based on many currencies. In this case a trade-weighted index (see below courtesy of the The Economist magazine) that combines the effects of changes against all currencies, weighted for effect based on the amount of trade.
The last time the US dollar was this cheap, was in 1995 before a very strong run and lows below an index level of 80 are rare. The low US dollar is also helping the economy, since exporters and domestic US companies are now far more competitive against foreign competitors.
Inflation low, but for long?
A couple of things can push up inflation. Higher commodity prices, which until last week, had been on a great run. Many however have come off their highs, quite strongly and falls of 20-30% have been seen such as sugar and silver. The lower US dollar also raises the chance of imported inflation directly as imports that can’t be substituted for local products rise in price. The only saving grace for inflation at the present moment is that excess capacity remains OK, slightly below average as mentioned earlier in the document, but further growth in domestic demand from a lower dollar could change things and push across into expansionary territory.
The big economic brake – House Prices
The oversupply of housing that led to a correction in the United States and the financial crisis in 2007 and 2008, remains the biggest stumbling block to economic growth. It holds down consumer confidence, consumer demand and makes employees less mobile – all negatives for the economy. Some estimate that up to 25% of US mortgages are underwater, but although this is a big number it misses a couple of bright spots in the housing market.
New and Existing Housing Supply Very Low
A recent Fortune article quoted Metrostudy, a housing data company showing that in 41 cities just 78,000 dwellings were vacant, for sale or under construction. In a normal buying period, that stock would disappear in 2.5 months. Granted, things aren’t normal and buyer appetite is low, but the big reduction is in new developments, which have ground to almost a halt since they can’t compete with the foreclosed stock. The oversupply that existed in during the boom has been, slowly, but surely, consumed and used up and on current usage levels will mostly disappear this year.
Affordability is higher than ever
In 28 of 54 markets its cheaper to buy than rent and that means that houses are certainly very cheap. This is a great statistic since it also shows that the income level required to pay mortgages, fundamental normal owner/occupier demand is still good and has now reached a strong level, a level above present prices even with high levels of unemployment.
What about the ghost overhang of foreclosures?
Many people fear the next cascade of defaults as foreclosures come on the market over the coming months and years. It is true, they will have a negative impact on the housing market, and without them housing prices would rise strongly. We remain in the opinion however that reduction in new supply offsets this effect. For two reasons. Not every home that is currently delinquent will end up in foreclosure due the increase in levels of employment. The other reason is the reduction in supply that we have mentioned before, but would like to go over again.
Some foreclosed houses will never be occupied.
Not every foreclosed house competes in the market. Some developments have been, or will be, bull-dozed or left vacant until they turn into dust. Some houses that have been stripped of their kitchen and some cases their wiring in a poor location where renovation doesn’t make economic sense now, and will remain on the market for many years until they are partially and in many cases eventually fully destroyed. Statistics don’t record these losses from supply, although they are nonetheless real. This isn’t speculation based on conjecture; we have seen many of these uninhabitable “propertiesCaterer Goodman, Economic Commentary, employment, Land Banking, Owen, Owen Caterer, Property, US recovery