The economy: Things are not as they ought to be

unemployment rates, december 2007

Virginia: 3.5 percent
Maryland: 3.8 percent
Delaware: 3.8 percent
New Jersey: 4.5 percent
Pennsylvania: 4.7 percent
West Virginia: 4.9 percent
United States: 5.0 percent
District of Columbia: 6.1 percent

Source: Bureau of Labor Statistics

By Dr. Anirban Basu

No one quite knows why, but many economists delight in bringing bad news to others. Right now, these economists couldn’t be happier.

Sources of angst pervade virtually every aspect of economic activity in America today, including the ongoing housing market slump in the face of falling mortgage rates, domestic auto manufacturers clinging to market share, an uncomfortably massive trade deficit, a fragile dollar, consumer confidence in free fall, additional anticipated mortgage rate resets, rising delinquencies, defaults and foreclosures, $90-per-barrel oil, $3-per-gallon gasoline, medical inflation, soaring food costs, heightened volatility on Wall Street and, of course, our ever expanding national debt.

That said, there are still some good things about the U.S. economy, and they are worth mentioning.

As of this writing, unemployment remains at just 5 percent, a level consistent with full employment. In Maryland, it has been below 4 percent for much of the year and stands at 3.8 percent currently. In Virginia, the unemployment rate stands at a paltry 3.5 percent, hardly a number consistent with the doom and gloom pervading consumer sentiment and CEO confidence surveys or the tenor of discussions in virtually all media outlets.

Despite the prevalence of tight labor markets and difficulty locating enough people to fill all of the nation’s job openings, there were approximately 1.5 million more people working nationwide in 2007 than there were in 2006. Maryland has added 36,000 net new jobs over the past year (December 2007 vs. December 2006), and the corresponding number in Virginia is 65,500.

The latest data also indicate that the economy continues to expand, though admittedly the pace of expansion has slowed to a near-recession like crawl. Gross domestic product expanded at a paltry 0.6 percent pace during the fourth quarter of 2007, and the first quarter of 2008 was as weak or worse. Employers also appear much more reluctant to create new employment opportunities, and the pace of job creation in 2008’s initial weeks was statistically indistinguishable from zero and possibly worse.

That said, thanks to a weakening dollar, our nation’s exports have become more competitive and export growth is now surging. Overall, exports expanded 13.7 percent over a recent 12-month period, with exports to India up 71 percent and up 16 percent to the European Union

The federal government’s stimulus package, combined with the Federal Reserve’s ongoing efforts to deal with the credit crunch and subprime mortgage situation, could conceivably have the nation’s economy humming later this year, but the first half of 2008 is shaping up to be an unusually difficult period for the U.S. economy. Segments of the economy are already clearly in recession, with the housing, mortgage and auto industries representing the most obvious instances.

But now a whole host of other sectors are teetering on the brink. Wall Street has been contracting, non-durable manufacturers that produce apparel, textiles, paper and furniture have been rocked, in large measure by ferocious foreign competition. Print media continues to contract and large retail segments also continue to struggle. Together, these industries comprise more than one-fifth of the nation’s output, according to Economy.com.

Many economists also conclude that the recession is spreading geographically, with California, Florida, Michigan, Ohio, Nevada and Wisconsin now in recession, according to reputable sources. These regional economies account for more than one-quarter of the nation’s gross domestic product.

And though recent decisions regarding monetary policy may not reflect it, inflation remains a concern. Producer prices for finished goods were up 6.8 percent in December 2007 compared to December 2006. This type of phenomenon constrains (or should constrain) the Federal Reserve’s ability to address the ongoing credit crunch while simultaneously retaining its credibility as a committed inflation fighter.

Market dynamics within the housing sector will probably deteriorate before improving. As many as 2 million adjustable rate subprime mortgages, worth $350 billion, are due to reset to higher interest rates in the United States over the next 18 months. At the same time, home prices are tumbling, which makes it difficult for people to refinance into fixed rate mortgages.

While policymakers in Washington D.C., Sacramento and elsewhere search for ways to minimize the harm of the impending foreclosure crisis, the current market is already under considerable duress. Average home prices are now falling on a year-over-year basis in much of the region, including in Anne Arundel County (-4 percent) Baltimore City (-4.2 percent), Cecil County (-8.5 percent) and Prince George’s County (-3.1 percent).

Looking ahead

Slowing macroeconomic growth probably means that the housing market’s bottom won’t occur until 2009 or later. Would-be buyers remain extraordinarily disengaged even in the face of falling prices and attractively priced money. This is typical in a deflationary environment, since the optimal strategy to adopt when prices are falling is to postpone purchases. What’s more, many would-be buyers know that selling their existing homes might be a bit of an ordeal under current circumstances, and in response, they’re staying put.

Keys to watch this year include oil prices, dollar weakness, the ongoing subprime / housing shakeout and the breadth of pain it delivers. Geopolitics may play an especially large role, as energy supply-based Russian hegemony and influence spreads, as the war in Iraq approaches a turning point, and as a variety of miscreants continue to destabilize various regions of the world, including South America, South Asia and the Pacific Rim.

Expect Maryland to add about 10,000 to 20,000 jobs this year, which would be its worst performance in several years. That level of job growth should be enough to keep unemployment below 5 percent in 2008, however.

Dr. Anirban Basu, is chairman and CEO of Sage Policy Group, Inc.