Tuesday, July 15, 2008

Below 11


Today the Dow closed below 11,000, falling to 10,962.54. Just a little more than half-a-year ago, in November 2007, it was over 14,000. The S&P, which exceeded 1550 in November, fell to 1214.91.

Fannie Mae and Freddie Mac, of course, are on everyone’s mind – as is the stability of the entire banking system. While a general banking collapse is not likely, it is true that the mortgage crisis infected many banks’ balance sheets. It will take a while for the system to work its way out of this predicament.

Of greater concern is the expenditure contraction that began in housing and is now starting to metastasize the overall economy. Many folks had become accustomed to applying their rising home equity toward the financing of automobile purchases. That avenue is now closed. And, as rising fuel prices make driving less attractive, auto sales have fallen.

Home sales and auto sales fell simultaneously in earlier recessions. This time auto sales lagged home sales’ drop. This lag provided a false sense of security – a hope that the housing malaise could be encapsulated and not infect other sectors. But that hope was in vain, and now the contraction in autos and related industries – rubber tires, steel, glass, fuzzy dice – will help pull down the rest of the economy. More ominously, auto’s decline will reinforce the housing debacle. That is, housing will sink further because the rest of the economy is ill.

Finally, business capital expenditures have also stalled. Why should business increase investment when the marketing outlook has become increasingly cloudy? If expenditures on plant and equipment – including technology – also fall, that will be the third leg – after housing and autos - knocked out from under the economy’s three-legged stool. The consequent recession could be long and dismal.

Today’s economic news provided further cause for concern. The Census Bureau (http://www.census.gov/marts/www/marts_current.pdf) said that “… advance estimates of U.S. retail and food services sales for June …(increased)… 0.1 percent (±0.5%)* from the previous month and 3.0 percent (±0.7%) above June 2007.” That’s especially weak if one recalls that economic-stimulus rebates were intended to boost consumer spending. The economic-stimulus package may have little benefit.

At the same time the Bureau of Labor Statistics said that (http://stats.bls.gov/news.release/ppi.nr0.htm) the “… Producer Price Index for Finished Goods increased 1.8 percent in June…” Multiplying by 12 provides a 21.6% increase at an annual rate – a real cause for concern.

No wonder Fed Chairman Ben Bernanke sounded so gloomy today when he delivered his semiannual monetary policy report to the Senate’s Committee on Banking, Housing, and Urban Affairs (http://www.federalreserve.gov/newsevents/testimony/bernanke20080715a.htm).

Chairman Bernanke summarized the situation as follows:

“At present, accurately assessing and appropriately balancing the risks to the outlook for growth and inflation is a significant challenge for monetary policy makers. The possibility of higher energy prices, tighter credit conditions, and a still-deeper contraction in housing markets all represent significant downside risks to the outlook for growth. At the same time, upside risks to the inflation outlook have intensified lately, as the rising prices of energy and some other commodities have led to a sharp pickup in inflation and some measures of inflation expectations have moved higher. Given the high degree of uncertainty, monetary policy makers will need to carefully assess incoming information bearing on the outlook for both inflation and growth. In light of the increase in upside inflation risk, we must be particularly alert to any indications, such as an erosion of longer-term inflation expectations, that the inflationary impulses from commodity prices are becoming embedded in the domestic wage- and price-setting process.”

It’s a serious dilemma.

© 2008 Michael B. Lehmann

No comments: