The Economy Has Hit Bottom

ALAN S. BLINDER

How’s the economy, you ask? I have the proverbial good news and bad news, but in this case, they’re exactly the same: The U.S. economy appears to be hitting bottom.

First, the good news. Right now, it looks like second-quarter GDP growth will come in only slightly negative, and third-quarter growth will finally turn positive. Compared to the catastrophic decline we recently experienced—with GDP dropping at roughly a 6% annual rate in the fourth quarter of last year and the first quarter of this year—that would be a gigantic improvement.

Furthermore, there is a reasonable chance—not a certainty, mind you, but a reasonable chance—that the second half of 2009 will surprise us on the upside. (Can anyone remember what an upside surprise feels like?) Three-percent growth is eminently doable. Four percent is even possible. Surprised? How, with all our economic travails, could we possibly mount such a boom? The answer is that this seemingly high growth scenario isn’t a boom at all. Rather, it follows directly from the arithmetic of hitting bottom.

Bear with me for two paragraphs while I do some numbers. In recent quarters, several critical components of GDP have declined at truly astounding annual rates—like minus 30% and minus 40%. You know the culprits: housing, automobiles and business investment. (Also inventories, about which more later.) Eventually, those huge negative numbers must turn into (at least) zeroes. Notice that the move to zero doesn’t constitute a boom, not even a dead cat bounce, but merely the cessation of catastrophic decline. In fact, hitting zero growth and staying there would be a disaster scenario. We’ll almost certainly do better.

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But watch what happens when—and remember, it’s when not if—the arithmetic of bottoming out takes hold. Housing, which is down to 2.6% of GDP, will serve as an example. In the first quarter, spending on new homes declined at a stunning 39% annual rate. If that minus 39% number turned into a zero in a single quarter, that change alone would add a full percentage point to that quarter’s GDP growth (because 2.6% of 39% is about 1%). If the move to zero were to happen over two quarters, it would add about a half point to each. Many people think housing may in fact bottom out in the third or fourth quarter. Autos may already have passed their low point. And business investment will follow suit.

Now back to inventories. Recent quarters have seen an almost unprecedented liquidation of inventory stocks, which means that American businesses were producing even less than the paltry amounts they were selling. That, too, must come to an end. As inventory change turns from a large negative number into just zero, GDP will get another a big boost.

Now the key point: None of these events are probabilities; they are all certainties. The only issue is timing, about which we can only guess. But if several of these GDP components happen to bottom out at roughly the same time, we could be in for a big quarter or two.

Feeling a little better? There’s more.

Remember the fiscal stimulus that everyone seems to be complaining about? One of the critics’ complaints is that little of the stimulus money has been spent to date. OK. But that means that most of the spending is in our future.

And remember all those interest-rate cuts the Federal Reserve engineered in 2008, in a futile effort to stem the slide? The Fed’s efforts were futile largely because widening risk and liquidity spreads negated any impacts on the interest rates real people and real businesses pay to borrow. Now those spreads are narrowing, which allows the Fed’s rate cuts to start showing through to consumer loan rates, business loan rates, corporate bond rates, and the like. In short, monetary stimulus is in the pipeline—a pipeline that was formerly blocked.

So why, then, is everyone feeling so blue? That brings me to the bad news: The U.S. economy is hitting bottom.

If things feel terrible to you, you’re not hallucinating. Economic conditions are dreadful at the bottom of a deep recession. Jobs are scarce. Layoffs abound. Businesses scramble for penurious customers. Companies go bankrupt. Banks suffer loan losses. Tax receipts plunge, ballooning government budget deficits. All this and more is happening right now, in what looks to be this country’s worst recession since 1938. At such a deep bottom, few people have reason to smile. (Bankruptcy lawyers maybe?)

What’s more, GDP is not terribly meaningful to most people. Jobs are—but they will take longer, maybe much longer, to revive. The last two recessions, while shallow, illustrated painfully that job growth may not resume for months after GDP bottoms out. And the unemployment rate won’t fall until job growth rises “above trend” (say, 130,000 net new jobs per month). That’s a long way from where we are today. So, even though the economy may be making a GDP bottom about now, the unemployment rate will probably keep rising for months—which is bad news for most Americans.

One last, obvious, but unhappy, point: The bottom of a deep recession leaves the nation in a deep hole. Our economy now has massive unemployment and vast swaths of unused industrial capacity. It will take years of strong growth to return to full employment.

After the last big recession bottomed out at the end of 1982, the U.S. economy rebounded sharply, with a remarkable six-quarter spurt in which annual GDP growth averaged 7.7%. That spurt induced President Ronald Reagan, running for reelection in 1984, to declare “It’s morning again in America.” Nobody thinks we can repeat that today, hampered as we are by a damaged financial system, decimated household wealth, rising foreclosures, and traumatized consumers who have suddenly learned the virtues of thrift.

So, yes, the good news is also the bad news. The economy is hitting bottom, but it’s a long, uphill climb to get out.

Mr. Blinder, a professor of economics and public affairs at Princeton University and vice chairman of the Promontory Interfinancial Network, is a former vice chairman of the Federal Reserve Board.

It's the Economy, Stupid

The Obama presidency will rise or fall on results.

KARL ROVE

Tomorrow will likely bring more bad news for President Barack Obama on the number one issue for voters -- the economy. The Labor Department's monthly job report will almost certainly show unemployment topping 9%, with a couple hundred thousand more jobs lost in May.

It will get worse before jobs get better. Congressional Budget Director Douglas W. Elmendorf recently predicted that unemployment will continue rising into the second half of next year and peak above 10%.

Mr. Obama has an ingenious approach to job losses: He describes them as job gains. For example, last week the president claimed that 150,000 jobs had been created or saved because of his stimulus package. He boasted, "And that's just the beginning."

However, at the beginning of January, 134.3 million people were employed. At the start of May, 132.4 million Americans were working. How was Mr. Obama magically able to conjure this loss of 1.9 million jobs into an increase of 150,000 jobs?

As my former White House deputy press secretary Tony Fratto points out on his blog, the Labor Department does not and cannot collect data on "jobs saved." So the Obama administration is asking that we accept its "clairvoyant ability to estimate," and the White House press corps has let Mr. Obama's ludicrous claim go virtually unchallenged.

About Karl Rove

Karl Rove served as Senior Advisor to President George W. Bush from 2000–2007 and Deputy Chief of Staff from 2004–2007. At the White House he oversaw the Offices of Strategic Initiatives, Political Affairs, Public Liaison, and Intergovernmental Affairs and was Deputy Chief of Staff for Policy, coordinating the White House policy making process.

Before Karl became known as "The Architect" of President Bush's 2000 and 2004 campaigns, he was president of Karl Rove + Company, an Austin-based public affairs firm that worked for Republican candidates, nonpartisan causes, and nonprofit groups. His clients included over 75 Republican U.S. Senate, Congressional and gubernatorial candidates in 24 states, as well as the Moderate Party of Sweden.

Karl writes a weekly op-ed for The Wall Street Journal, is a Newsweek columnist and is now writing a book to be published by Simon & Schuster. Email the author at Karl@Rove.com or visit him on the web at Rove.com.

Or, you can send him a Tweet @karlrove.

Still, there are limits to Mr. Obama's rhetorical tricks. Even he cannot turn job losses into real job gains. And he won't be rescued by stimulus spending.

Former National Economic Council Director Keith Hennessey made a persuasive case on his blog that the stimulus will be ineffective because the additional economic growth it spurs will come six to nine months later than it could have.

This is partly because, as the Congressional Budget Office estimates, only $185 billion (23% of a $787 billion stimulus package) will be spent this fiscal year. The government will spend an additional $399 billion next fiscal year. The balance -- $203 billion -- will be spent between fiscal years 2011 and 2019, long after the economy has turned on its own power and for its own reasons. In addition, much of the stimulus that went this year for tax cuts and transfer payments has been saved, not spent. (The national savings rate went from less than 0% to about 5%.)

If the Obama administration were more serious about growing the economy than just growing government, the stimulus would have been front-loaded into this fiscal year.

In addition, the claim made by Team Obama that every dollar in stimulus translates into a dollar-and-a-half in growth is economic fiction. The costs of stimulus reduce future growth. No country has ever spent itself to prosperity. The price of stimulus has to be paid sometime.

Any real improvement in the economy so far is more likely the result of the Federal Reserve expanding the money supply and the Fed and Treasury shoring up the financial sector.

But the Fed's actions are risky. Easy money and expansionary policies are not sustainable. We may soon be in for a bout of inflation unless the Fed soaks up much of the money it flooded into the system. The government is also likely to hamper private investment as it uses a vast amount of capital to finance its debt. And when the Fed stomps on its monetary brakes, as eventually it must, we'll get sluggish growth.

The irony for Democrats is that the Fed may hit the brakes in the run-up to the 2010 congressional elections or the 2012 presidential election.

It is becoming clear that the economy is now the top issue. Mr. Obama's presidency may well rise or fall on it. The economy will be his responsibility long before next year's elections. Americans may give him a chance to turn things around, but voters can turn unforgiving very quickly if promised jobs don't materialize.

That's what happened in Louisiana, where voters accepted Democrat Gov. Kathleen Blanco's missteps before Hurricane Katrina but brutally rejected her afterward because she failed to turn the state around.

Until now, the new president has benefited from public willingness to give him a honeymoon. He decided to use that grace period to push for the largest expansion of government in U.S. history and to reward political allies (see the sweetheart deals Big Labor received in the GM and Chrysler bankruptcies).

The difficulty for Mr. Obama will be when the public sees where his decisions lead -- higher inflation, higher interest rates, higher taxes, sluggish growth, and a jobless recovery.

Mr. Rove is the former senior adviser and deputy chief of staff to President George W. Bush.

Bank Nationalization

Bank Nationalization Isn't the Answer

Trust me. I've done this before.

WILLIAM M. ISAAC

People who should know better have been speculating publicly that the government might need to nationalize our largest banks. This irresponsible chatter is causing tremendous turmoil in financial markets. The Obama administration needs to make clear immediately that nationalization -- government seizing control of ownership and operations of a company -- is not a viable option.

Unlike the talking heads, I have actually nationalized a large bank. When I headed the Federal Deposit Insurance Corporation (FDIC) during the banking crisis of the 1980s, the FDIC recapitalized and took control of Continental Illinois Bank, which was then the country's seventh largest bank.

The FDIC purchased Continental's problem loans at a big discount and hired the bank to manage and collect the loans under an incentive arrangement. We received 80% ownership of the company, which increased to 100% based on the losses suffered by the FDIC on the bad loans.

We replaced Continental's senior management and most of its board of directors. We required the bank to submit a business plan to shrink to half its size within three years. All major decisions required FDIC approval, including the hiring, firing and compensation of senior management, and the undertaking of new business endeavors.

The takeover occurred in 1984, the FDIC completed the sale of its ownership stake seven years later, and Continental was purchased by Bank of America in 1994. The old shareholders ultimately received nothing, all creditors and preferred shareholders came out whole, and the FDIC suffered what we considered a reasonable loss: $1.6 billion.

So, you might wonder, what's so bad about nationalization? It appears to have worked well at Continental.

Let's begin with the fact that today our 10 largest banking companies hold some two-thirds of the nation's banking assets, and some are enormously complex. Continental had less than 2% of the nation's banking assets, and by today's standards it was a plain-vanilla bank. This is important for three reasons.

First, any bank we nationalize will be forced, both by the regulators and the marketplace, to shrink dramatically. We are in the middle of a serious economic downturn where deflation is a realistic concern. Do we really think that dismantling our largest banks would be helpful? I don't.

What's more, we won't be able to stop at nationalizing one or two banks. If we start down that path, the short sellers and other speculators that the Securities and Exchange Commission still refuses to re-regulate will target for destruction one after another of our largest banks.

Second, for nationalization to work there needs to be a reasonable exit strategy. In the case of Continental, we had scores of options for returning the bank to private hands, including a public offering or a sale to any number of domestic and foreign banks and investor groups.

Today, who has the wherewithal, legal authority, and desire to purchase our largest banks? No one comes to mind, particularly if we rule out foreign groups, which I suspect would not pass muster due to national security concerns about ceding that much power over our economy to foreign powers.

Third, who will run these companies when we dismiss the existing senior managers and board members? We had significant difficulties attracting quality people to Continental even without today's limits on compensation.

So-called experts frequently cite the success of the Swedish experience with bank nationalization in the last decade. Nothing could be less relevant. Sweden's population, economy and banking system are roughly the size of Ohio's. Sweden's largest bank is roughly 10% the size of each of our three largest banking companies. Moreover, Sweden nationalized only Gota Bank -- and that was after it had already collapsed.

The Obama administration should declare that nationalization of any major bank is off the table; that the government stands behind our entire banking system; and that our banks will continue to receive a nonvoting form of equity capital, such as convertible preferred stock, from the government to the extent needed. Yesterday's joint announcement to this effect by the Federal Reserve, FDIC, the Comptroller of the Currency, and the Treasury is a critical step toward healing our banking system and economy. Well done.

Mr. Isaac, chairman of the FDIC from 1981-1985, is chairman of the Washington financial services consulting firm The Secura Group, an LECG company.

The Pelosi Placebo, or how to anesthetize the economy for fun and profit

The Pelosi Placebo, or how to anesthetize the economy for fun and profit

The first thing we have to do is stop calling it a “stimulus package.”

In an earlier post, I described it in passing as the Pelosi Placebo–”Pelosi,” after the person primarily responsible for overseeing this “legislative abomination,” “Placebo,” “something lacking intrinsic remedial value and that is done or given to humor another.” In this case, “another” are congressional Democrats who have been straining at the bit for years to glom on to your money for this or that spending spree and have suddenly hit upon a new formula: “People don’t like it when we go massively into debt in order to act out our redistributionist spending fantasies, so let’s not call it the mother of all spending bills (which is what it really is) but, rather, a ’stimulus package.’ It will take ages for the suckers whose lives we run to notice that the only thing this trillion dollars stimulates is credulousness.”

As Karl Rove noted in The Wall Street Journal the other day, what Congress is preparing to shove down our throats is “a mammoth spending bill, not a stimulus or jobs package.”

It is not surprising that the stimulus package is laden with new spending programs. Congressional appropriators, not job creators, wrote H.R. 1. Much of it is spending Democrats couldn’t get approved in the normal course of affairs. And it should not shock Americans that Democratic appropriators would funnel tax dollars to the Association of Community Organizations for Reform Now, unions and other liberal special interests.

Rove is right, but he really should follow his own point and refrain from calling this piece of legislative larceny a “stimulus package.” It is not a stimulus package, except in the derivative sense that it can be counted upon to stimulate that appetite for ever more government spending.

It’s not a stimulus package. Then what is it? A fraud on the taxpayer? Yes. A massive transfer payment to various Democratic special interests? Yes. Another notch in the ratchet that is pushing the United States in the direction of top-down bureaucratic socialism à la Sweden? You betcha. Mark Steyn produced what is perhaps the most vivid analogy. You know that unemployed mother of six who, thanks to the miracle of modern medicine, just gave birth to another 8 babies? She’s been all over the news and has been the object of lots of finger waving. But why criticize her for irresponsibility when your government (forgive that anachronistic “your”) is doing the same thing, but on a much, much bigger scale. As Steyn explains,

last week, I got a little muddled over two adjoining newspaper clippings – one on the stimulus, the other on those octuplets in California – and for a brief moment the two stories converged. Everyone’s hammering that mom – she’s divorced, unemployed, living in a small house with parents who have a million bucks’ worth of debt, and she’s already got six kids. So she has in vitro fertilization to have eight more. But isn’t that exactly what the Feds have done? Last fall, they gave birth to $850 billion of bailout they couldn’t afford and didn’t have enough time to keep an eye on, and now, four months later, they’re going to do it all over again, but this time they want trillionuplets. Barney and Nancy represent the in vitro fertilization of the federal budget. And it’s the taxpayers who’ll get stuck with the diapers.

And diapers, of course, are only the beginning of the unpleasant byproducts this orgy of spending will create. Even the Congressional Budget Office estimates that only 7 percent of the zillions of dollars Congress is about to extract from your pocket would “be injected into the economy by the end of fiscal year 2009. More than $200 billion of ’stimulus’ funds will be spent between fiscal year 2010 and fiscal year 2019 — long after the recession is projected to be over.” Former scourge of feminists, now White House economic advisor, Larry Summers said that any stimulus must be “targeted, timely and temporary.” Good luck, Larry! Karl Rove is right: “This bill does the opposite. Mr. Obama pledged to ’scour our federal budget, line by line, and make meaningful cuts.’ His cuts are unspecific and fanciful, while Congress’s spending will be real and record-setting. Discretionary domestic spending will have nearly doubled by the time Mr. Obama stops dithering and starts scouring.”

Everybody noted how Obama stopped talking “hope and change” and started warning about “catastrophe” as soon as serious opposition to his profligate spending plan showed itself. He wants the money, he wants it now, and he wants it to “spread the wealth around,” pay back his constituents, and acclimate more people to government handouts. “I won,” Obama said when Republicans in the Senate had the temerity to question the wisdom of his spending blowout. Yes, he won alright. But how about the rest of us?