Second Stimulus - Good Money After Bad

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
July 21, 2009

IN THIS ISSUE:

1. The Latest Assessment of the US Economy

2. The Real Unemployment Rate is 16.5%, Not 9.5%

3. Nine Reasons the Economy is Not Getting Better

4. Where I Disagree With Mr. Zuckerman

5. Conclusions – “The New Normal”

Introduction

Over the last few weeks, most polls have shifted to indicate that a majority of Americans now believe President Obama’s massive $787 billion stimulus package that he signed into law on February 17 has been a failure in terms of restarting the economy. I could not agree more. Rather than making the money available to immediate job-creating projects and programs, Obama and the Democrats in Congress loaded the stimulus up with pork-barrel projects that will take years to come about, and the recession will likely be over well before that.

I warned about this repeatedly in my February 10, 17 and 24 E-Letters. I was not a fan of the massive $787 billion stimulus package, but most of my best sources agreed that the government needed to step in with some kind of stimulus to at least partially fill the gap left by the marked slowdown in consumer spending. But the $787 billion spending package, which was spread out over 3-4 years, was not what we needed to jump-start the economy. It is now estimated that only about 10% of the stimulus money has been spent at this point. No wonder unemployment is 9.5% and rising fast.

Now we have widespread talk in Washington and elsewhere of a second huge stimulus package. Oh, but this time the politicos in Washington claim that they’ve learned their lesson, and a second stimulus will be focused only on “shovel-ready” programs that will create new jobs right away. To that I say (as my kids often do): yeah, right! I have a different suggestion: forget a second stimulus and redirect the remaining 90% of the $787 billion first stimulus to projects that will create jobs now. And include a payroll tax holiday for six months or so to boot.

In addition to the second stimulus issue, we will touch several other bases in this week’s E-Letter. We will begin with the latest economic reports which remain mixed to negative. The theme of “green shoots” and an economic recovery that became popular in April and May has since turned more negative in June and so far in July. Consumer confidence is falling once again as it increasingly becomes clear that this recession will not be over anytime soon, and that the recovery will almost certainly be tepid over the next couple of years.

Following that discussion, we will look at a recent article which details why the real unemployment rate in the US is much, much worse than the monthly Labor Department reports depict. Most of you, I suspect, are aware of this, but the report I will share with you below puts the situation in much clearer terms, and explains why the economic recovery is likely doomed to be lackluster over the next couple of years or longer.

While this definitely won’t be one of my more upbeat E-Letters, the circumstances are what they are and you need to know about it, especially as you try to manage your money and plan for retirement in this very challenging environment. Let’s get started.

The Latest Assessment of the US Economy

On June 25, the Commerce Department released its final report on 1Q GDP at -5.5% (annual rate). That was slightly less negative than the prior estimate of -5.7%. The 1Q decline followed the 6.3% decline in the 4Q of 2008. Most analysts now expect that GDP will be negative for the 2Q as well, but not nearly as bad as the 1Q. A good number of analysts and economists continue to believe GDP will return to mildly positive territory by the 3Q, but that remains to be seen.

The Index of Leading Economic Indicators (LEI) rose for the third month in a row in June, up 0.7% following the rise of 1.2% in May. This is encouraging and seems to confirm that we have seen the worst of the recession and the credit crisis, but it does not suggest that this deep recession is over yet. Retail sales also increased modestly in June, up 0.6% following a gain of 0.5% in May, a sign that things are improving but we are not nearly out of the woods yet.

Unfortunately, the Consumer Confidence Index fell from 54.8 in May to 49.3 in June. The index had risen for three months in a row until the June decline. The University of Michigan Consumer Sentiment Index fell from 70.8 in June to 64.6 so far in July. I believe it is clear that consumers are coming to realize that this recession, while we’ve likely seen the worst of it, is not going away anytime soon.

As we will discuss in detail below, the unemployment rate surged to 9.5% in June, above expectations. Most analysts, including President Obama, now predict that the unemployment rate will go above 10% in the months ahead and will not likely peak until sometime in the second half of 2010. As we will explore later on, the “headline” unemployment rate published by the Labor Department significantly understates the true level of unemployment.

Factory orders and durable goods orders both rose for the second month in a row in May (latest data available). The ISM Manufacturing Index rose modestly in June to 44.8, up from 42.8 in May. Remember, any ISM number below 50 indicates recession. Industrial production fell by 0.4% in June, and the factory operating rate (capacity utilization) continued to fall in June to only 68.3%, down 13.6% over the last 12 months.

Sales of new and existing homes appear to be bottoming out with a very modest rise in May/June. Housing starts actually rose slightly in May/June as well. Unfortunately, the home foreclosure rate continues to soar, rising 4.6% in June and 33% over the last 12 months. The housing crisis is still far from over.

While it is encouraging that we have had some positive economic reports over the last several weeks, most economists continue to lower their forecasts for the last half of the year. I continue to believe that this recession will last longer than the current consensus predicts.

The Real Unemployment Rate is 16.5%, Not 9.5%

I have known for more than two decades that the official Labor Department “unemployment rate” significantly understates the number of Americans who are out of work each month. Most likely, many of you are also aware of this longstanding disparity. A number of other official government reports contain similar disparities. But since the markets react to these government reports as if they are accurate, I report them in these pages accordingly.

With that in mind, I was pleasantly surprised to read an article last week by the Editor-in-Chief of U.S. News & World Report, Mort Zuckerman, that very accurately described the fallacies in the Labor Department’s monthly unemployment report. I don’t think I have ever seen these fallacies reported so accurately and concisely in one place. Mr. Zuckerman also reveals what he sees for the future of the US economy and the jobs market in the years to come.

So, I will reprint it for you below. While I don’t agree with Mr. Zuckerman’s conclusions as to what should be done now, I trust you will find the following of great interest.

QUOTE:

Nine Reasons the Economy is Not Getting Better
Jobs data paint a discouraging picture of more pain to come
By Mortimer Zuckerman
Posted July 13, 2009

We are now looking at unemployment numbers that undermine any confidence that we might be nearing the bottom of the recession. The appropriate metaphor is not the green shoots of new growth. A better image is to look at the true total of jobless people as a prudent navigator looks at an iceberg.

What we see on the surface is disconcerting enough. The estimate from the Bureau of Labor Statistics of job losses for June is 467,000. That increases by 7.2 million the number of unemployed since the start of the recession. The cumulative job losses over the past six months have been greater than for any other half-year period since World War II, including demobilization. What's more, the job losses are now equal to the net job gains over the previous nine years, making this the only recession since the Great Depression to wipe out all employment growth from the previous business cycle.

That's bad enough. But here are nine reasons we are in even more trouble than the 9.5 percent unemployment rate indicates.

One. June's total included 185,000 people who were assumed to be at work, many of whom probably were not. The government could not identify them; it made an assumption about trends. But many of the mythical jobs are in industries that have absolutely no job creation: finance, for example. When the official numbers are adjusted over the next several months, look to some of the 185,000 boosting the unemployment totals.

Two. More companies are asking employees to take unpaid leave. These people don't count on the unemployment roll.

Three. No fewer than 1.4 million people wanted or were available for work in the past 12 months. They were not counted. Why? Because they hadn't searched for work in the four weeks preceding the survey. The assumption is that they had found work or don't want it, but there are other explanations: school attendance, family responsibilities, sheer exhaustion.

Four. The number of workers taking part-time jobs because of the slack economy, a kind of stealth underemployment, has doubled in this recession to about 9 million, or 5.8 percent of the workforce. Add those whose hours have been cut to those who cannot find a full-time job, and the total of unemployed and underemployed rises to 16.5 percent, putting the number of involuntarily idle workers in the range of an overwhelming 25 million. [Emphasis added, GDH.]

Five. The inside numbers are just as bad. The average workweek for production and nonsupervisory private-sector employees, around 80 percent of the workforce, dropped to 33 hours. That's 48 minutes a week less than before the recession began, the lowest level of activity since the government began tracking such data 45 years ago. Full-time workers are being downgraded to part time as businesses slash labor costs to remain above water and factories operate at only 65 percent of capacity. If American workers were still putting in those extra 48 minutes a week now, 3.3 million fewer employees could perform the same aggregate amount of work. With a longer workweek, the unemployment rate would reach 11.7 percent, not the official 9.5 percent (which in turn dramatically exceeds the 8 percent rate projected by the Obama administration).

Six. The average length of official unemployment increased to 24.5 weeks. This is the longest term since the government started to track these data in 1948. The number of long-term unemployed (those out of a job for 27 weeks or more) has now jumped to 4.4 million, an all-time high.

Seven. The average worker saw no wage gains in June, with average compensation running flat at $18.53 an hour.

Eight. The jobs report is even uglier when you consider that the sector producing goods is losing the most jobs—223,000 in the last report alone.

Nine.The prospects for job creation are equally distressing. The likelihood is that when economic activity picks up, employers will first choose to increase hours for existing workers and bring part-time workers to full-time status.

Many unemployed workers looking for jobs once the recovery begins will discover that jobs as good as the ones they lost are almost impossible to find because more layoffs in this recession have been permanent and not temporary. Instead of shrinking operations, companies have closed whole business units or made sweeping structural changes in the way they conduct their business.

For example, General Motors and Chrysler shut down hundreds of dealerships and reduced brands; Citigroup and Bank of America cut tens of thousands of jobs and exited many parts of the world of finance. In other words, we could face a very low upswing in terms of the creation of new jobs, and we may be facing a much higher level of joblessness on an ongoing basis. Job losses may last well into 2010 to hit an unemployment peak close to 11 percent. And then joblessness may be sustained for an extended period.

Can we find comfort in knowing that employment has long been considered a lagging indicator? It is conventionally seen as having limited predictive power because employment reflects decisions taken earlier in the business cycle. But today is different. Unemployment has doubled from 4.8 to 9.5 percent in just 16 months, a record rate so fast it may influence future economic behaviors and outlooks.

Bear in mind that the lackluster increase in inventories suggests that there's little prospect in the pipeline of real growth in consumption, investment, and exports. So the terrible state of the labor market is likely to be a strong head wind against consumer spending for a long time as wages and overall income growth are decelerating and households, within a fairly short period, will have received their full portion of the [$787 billion] stimulus package.

How could this happen when Washington has thrown trillions of dollars into the pot, including the famous $787 billion in spending that was supposed to yield $1.50 in growth for every dollar spent? For a start, too much of the money went to transfer payments—Medicaid, jobless benefits, and the like - that do nothing for jobs and growth. The spending that creates new jobs is new spending, particularly on infrastructure. It amounts to less than 10 percent of the stimulus package today.

Second, the stimulus package may have been well intentioned, but it was [arguably!] too small and [definitely!] too badly constructed to get money into the economy fast enough to replace lost consumer and business spending and to slow unemployment. Workers' pessimism is justified: About 40 percent believe the recession will continue for another full year. As paychecks shrink and disappear, consumers are more hesitant to spend and won't lead the economy out of the doldrums quickly enough.

It may have made him unpopular in parts of the Obama administration, but Vice President Joe Biden told it as it is when he said the administration misread how bad the economy was. The administration inherited the problem, but then it failed to understand how ineffective its solution would be. The program was supposed to be about jobs, jobs, and jobs. It wasn't. The recovery act may have been a single piece of legislation, but it included thousands of funding schemes for tens of thousands of projects, and those programs are stuck in the bureaucracy as the government releases the funds with typical inefficiency. [Emphasis added, GDH.]

An additional $150 billion, which was allocated to state coffers so as to continue existing programs like Medicaid, did not add new jobs. Hundreds of billions of dollars were set aside for tax cuts and for new benefits for the poor and the unemployed, and that did not add new jobs. Now state budgets are drowning in red ink as jobless claims and Medicaid bills climb.

Next year, state budgets will have depleted their initial rescue dollars. Absent another rescue plan, they will have no choice but to slash spending or raise taxes, or both. The complete state and local government sector, which makes up about 15 percent of the economy, is beginning the worst contraction in postwar history in the face of a [combined state] deficit gap of $166 billion for fiscal year 2010, according to the Center on Budget and Policy Priorities, and a cumulative gap of $350 billion in fiscal year 2011.

Similarly, households overburdened with historic levels of debt will be saving more. The savings rate has already jumped from zero in 2007 to almost 7 percent of after-tax income now, and it is still rising. Every dollar of saving comes out of consumption. Because consumer spending is the economy's main driver, we are going to have a [continued] weak consumer sector, and many businesses simply won't have the means or the need to hire employees.

In the aftermath of the 1990-1991 recession, Americans bought houses, cars, and other expensive goods. This time, the combination of a weak job picture and a severe credit crunch means that people won't be able to get the financing for big expenditures, and those who can borrow will be reluctant to do so.

In recent times, Americans found myriad ways to fuel spending, even as incomes stagnated: borrowing against the once rising price of their homes and tapping plentiful credit cards. No longer. The paycheck has returned as the primary source of spending, and pay is eroding even for those who have jobs. This process is nowhere near complete, and, until it is, the economy will barely grow, if at all, and may well oscillate between sluggish growth and modest decline for the next several years until the rebalancing of the excessive debt has been completed. Until then, the private economy will be deprived of adequate profits and cash flow, and businesses will not start to hire. Nor will they race to make capital expenditures when they have vast idle capacity.

In other words, there are many more reasons today to expect the downturn to continue than to expect a turnaround. Consumer spending and residential investment could be even weaker than most estimates, and, as the level of fiscal stimulus begins its decline in the second half of 2010, we may be facing an even more difficult future. [Emphasis added, GDH.]

No wonder poll after poll shows a steady erosion of confidence in the stimulus measures. One survey even showed 45 percent believe the limited [stimulus] results suggest they should simply be abandoned midway. The disappointment is understandable - but that would only make things worse. So what kind of second-act stimulus program should we look for? This time, it should not be an excuse to pass a lot of programs like those in the first stimulus package that do not really have the kind of multiplier effect on job creation and on economic growth that was intended.

In any event, given the trends, it is absolutely critical that the Obama administration not play politics with the issue but really begin to prepare a second stimulus program, so that if the economy does take a major downturn, it will be possible this time to provide much more rapid government support to infrastructure spending that will maximize the creation of jobs. The time to get ready is now.
END QUOTE

Where I Disagree With Mr. Zuckerman

It is now clear that President Obama’s initial $787 billion stimulus package was badly misguided. We can agree or disagree on whether it should have been passed in the first place. But what is not in question any longer is that the bulk of the near-$1 trillion spending package was made up of pork-barrel spending that will be years in creating any meaningful jobs.

Now, Mr. Zuckerman and others are calling for another large stimulus package. Who knows how large the next one will be, but I would guess that it will be at least another $500 billion to $1 trillion. The new stimulus we’re hearing about will, they say, somehow be successful in creating large numbers of jobs in the near-term. But why in the world should we believe that? I certainly do not.

My suggestion is as follows. As reported widely, only apprx. 10% ($60-$70 billion) of the $787 billion stimulus package has actually been spent thus far. How about we reallocate the remaining $700+ billion from long-term liberal spending programs to job-creating programs in the short-term, and forget about a second stimulus program?

Of course, this is just wishful thinking on my part – it will probably never happen, unfortunately. If the economy continues to languish, as I expect it will for another year or two, there will very likely be another stimulus package that will likely add another trillion or so to our already bulging national debt.

Conclusions – “The New Normal”

It is becoming increasingly clear to economists, market analysts and investors that the US economy is not going to come roaring back from this severe recession and credit crisis anytime soon. In light of the sharp increase in the personal saving rate, consumer spending no longer accounts for 70-72% of GDP and is not likely to do so for the foreseeable future as Americans are increasingly paying down debt (deleveraging) and hoping they can hang onto their jobs.

We are not going back anytime soon to the go-go days of the late 1990s when tech stocks exploded and we saw the greatest stock bull market in history when equity gains fueled record large consumer spending. Likewise, we are not going back to the real estate/refinance boom of the 2000s when home prices exploded and consumer spending hit even new record highs anytime soon.

I agree with Mr. Zuckerman that the most likely scenario when we finally come out of this recession is a “range-bound” economy that fluctuates back and forth from slightly negative growth to slightly positive growth for the next several years. Analysts are increasingly referring to this scenario as “The New Normal.”

Meanwhile, President Obama is spending trillions after trillions that we do not have on big government programs that may or may not work, but will certainly increase government control in our lives and our pocketbooks (ie- higher taxes). Another huge new stimulus package may be just around the corner, along with nationalized healthcare at an estimated cost of $1.5 trillion (and we all know how good the government is at estimating costs). Never mind that we have a massive Social Security and Medicare crisis facing us in the next 5-10 years.

I don’t pretend to know exactly where all of this is headed, but I cannot see it ending pretty on any front. The stock markets have rallied a fair amount since the March lows, which is not surprising given how hard they plunged since this recession began in late 2007. Maybe the March lows were the bottom, maybe not.

It has long been argued that stocks tend to lead the end of major recessions by 6-9 months. In the past, this has been true on numerous occasions. But as Mr. Zuckerman opined above, things are very different this time around. The “New Normal” is definitely new and is anything but normal.

If we are destined for an extended period of “range-bound” economic growth as I believe, that very likely means an extended broad trading rage in stocks, and probably bonds as well. All of this suggests, more than ever, that you need some alternative investment strategies that can move among different market sectors and can move to the safety of cash (or hedge long positions) when market conditions turn ugly.

If you agree, you know where to find us: 800-348-3601 or www.halbertwealth.com.

Wishing you a great summer,

Gary D. Halbert

SPECIAL ARTICLES

The Squandered Stimulus
http://www.realclearpolitics.com/articles/2009/07/20/the_squandered_stimulus.html

Obama’s Summer of Discontent
http://www.commentarymagazine.com/viewarticle.cfm/obama-s-summer-of-discontent-15208

Why Toxic Assets Are So Hard to Clean Up
http://online.wsj.com/article/SB124804469056163533.html