The Case for Confidence

The United States is recovering from an economic slowdown that began in the summer of 2000. The pain of families hurt by the loss of jobs and savings is highly visible and real.

But there is good news: Thanks to President Bush's strong leadership in the face of multiple challenges, America is on the road to recovery. We should all share the President's confidence and optimism in our country's future.

I know that it's easy to feel otherwise, given the nightly news coverage of the painful human side of the downturn. But that is not the complete story.

The reasons for our confidence are explained in the enclosed memorandum. As you will see, there are plenty of data to show that the United States is recovering from a mild recession.

I trust that you share our Administration's optimism, and I hope you will continue to let us hear your ideas for promoting further growth. Meanwhile, thank you for your contributions to keeping our country and communities strong.

Donald L. Evans

 

---

 

		October 3, 2002
	TO: Interested Parties
	FROM: Donald L. Evans
	SUBJECT: The Pessimists Are Ignoring Important Economic Vital Signs

As we look ahead to next year, economic growth and putting people back to work should be our top economic priorities.

Terrorism and the situation with Iraq are clearly causing uncertainty. Investor confidence is shaky due to the unethical practices of a few that harmed the retirement savings of many. Yet, there is more than ample cause for optimism about the economy. Recoveries do not move in a straight line. Recoveries are uneven. Different industries are impacted in different ways - some will bounce back more quickly, some more slowly.

It is also true - though underreported - that because we have just experienced an extremely mild recession, it usually takes longer to jumpstart robust growth. Indeed, the President and Congress enacted policies -- tax cuts, accelerated depreciation, extended unemployment benefits, post-September 11 emergency spending -- that ensured the recession was the mildest since World War II.

Most of the economy is following a normal recovery pattern. Consumers remain upbeat for this stage of recovery and are continuing to spend, the ultimate requirement for a significant investment turnaround. Businesses are beginning to build inventories -- a sign of an improving production trend on the horizon -- and telltale signs of a turn in business equipment investment are encouraging as well.

As the President himself said, "I'm optimistic because…we've got the best workers in the world, inflation is down, interest rates are low. So when you combine the productivity of the American people with low interest rates and low inflation, those are the ingredients for growth."

Job Growth Needed

We now know that President Bush inherited a recession. He acted decisively - and now that the results are in, we know wisely - to cut taxes just months after he assumed office. Thanks to his forward-looking vision, the recession was milder than it otherwise, no doubt, would have been.

We were still in recession when the economy took a stunning blow on September 11, 2001. The devastating attacks could have sent confidence into a downward spiral. But because of President Bush's strong leadership, they did not. So here we are, just a year later, and even though we would like to see stronger employment growth, there can be no question that today's economy shows positive signs.

Payroll employment is growing, although modestly. On Friday, we will see an updated view of employment. Given the volatility of the measure in any given month, it is difficult to know what we will see. But what is important is that employment has increased by a net of 136,000 in the past six months (February through August), after falling nearly 1.8 million between March 2001 and February 2002.

By comparison, employment continued to fall for a year after the end of the last recession and did not recover its prior peak until nearly three years after the deterioration began.

The Administration remains focused on getting Americans back to work. It is important to remember, however, just how dynamic and flexible the U.S. job market is and how much churning occurs -- providing opportunities for those whose jobs have disappeared. While we read a great deal about job cuts, we know from an August Labor Department report that hires as well as separations have exceeded 4 million per month in recent months.

Productivity Growth Remains Robust

Higher productivity is a clear positive. Productivity has trended upward at a 2.6% annual rate over the past seven years. The strong trend has persisted over the last five quarters, despite the recession. Only the 1960s experience was more robust than this period - signaling sizable gains in living standards ahead as well as cost savings for businesses.

Inflation Is Low

Prices rose only 1.8% over the past year, well below the 2.5% average of the 1992-2001 period. This allows the Federal Reserve to maintain low interest rates and reasonable financing conditions for households and businesses alike.

Household Incomes Growing Strongly

After-tax incomes adjusted for inflation rose 5% from mid-2001 to mid-2002 and at a 7% pace through August of this year. This income performance compares favorably with only 3% growth during the boom years of the late 1990s. Furthermore, it is stronger than is typical during recession/recovery periods and on par only with the 1969 period.

 

This strong performance is particularly important, since income growth is many times more effective than wealth changes in driving spending.

Household Spending Remains Vigorous

Inflation-adjusted consumer spending has grown more than 3.5% over the past year. Only the 1960s consumer spending experience is stronger than the current one, with growth far above the norm for this stage of an economic recession/recovery.

The lowest mortgage rates in 30 years and near-zero auto finance rates have boosted new and existing home construction and sales as well as auto purchases.

• Housing starts - at a 1.7 million rate this year - are the strongest of any year since 1987 and are particularly robust for this stage of expansion.
• The pace of new and existing home sales has set a record thus far this year of 6.6 million.
• The pace of auto sales has reached nearly 18.5 million in the last two months and nearly 17 million thus far this year - equivalent to peak levels of 1999 to 2001 but far above any prior years.

Housing affordability - taking into account not only prices but financing costs -- remains near its highs of the past 10 years. This is no doubt a prime reason why home ownership rates remain close to their all-time highs, for young and old alike.

Consumer Debt Steady

Despite worries to the contrary, household debt service-to-income ratios are no higher today than in the mid-to-late 1980s. Furthermore, delinquency rates on a broad range of household debt are remarkably similar to their levels over the past 20 years.

Consumer Confidence Solid

Consumer confidence, according to the University of Michigan, compares favorably to readings during expansions in the 1980s and early 1990s. Very simply, consumer sentiment was unusually high in the late 1990s. Today, despite a recent falloff, consumer sentiment remains solid. The increased number of two-worker families no doubt provides stability to household incomes and adds to consumer confidence.

Household Wealth Holding Up

Nor are wealth changes as gloomy as widely cited. While stock values have fallen sharply since the first quarter of 2000, the value of real estate owned by households has risen 23 percent.

Analysts have tended to focus on the decline in the stock market, the value of which fell by 46% from the first quarter 2000 through the second quarter of this year and represents a loss of $4.3 trillion in equity wealth. It is important to keep in mind, however, that all of this wealth creation occurred post-1997 - a short five years ago - the last time we experienced stock market values close to today's levels. Furthermore, household wealth was impacted considerably more for higher-income than for moderate to lower-income households. And, finally, the strong growth in real estate values has offset much of the wealth lost in the stock market, bringing overall household assets down a mere 4%.

Industry Performance Varied

Some industries remain troubled due to recession and/or the attacks, but many industries in this economy successfully weathered both.

• Seriously troubled industries include, of course, the telecom, airlines, and aircraft production industries.
• A wide range of other industries continue to suffer revenue declines this year versus last year - from insurance to printing and publishing, securities and investment companies, and more. The hotel industry has not fully recovered, but occupancy rates in August were some 2% below year-ago levels versus 25% below at their worst.
• An increasing number of industries, especially those closely tied to persistent consumer demand or housing construction and furnishings, have fared much better.

Corporate Profits on the Rise

The rebound in profits over the last year, coupled with lower taxes, provides companies with more internal funds with which to finance new investment. S&P 500 operating earnings per share were up 28 percent in the second quarter from a year ago.

History demonstrates a lagged link between the turn in both profits and sales and the turn in capital spending. Thus, the drumbeat of improved profitability is encouraging for future capital spending as well as employment.

Capital Spending Turnaround Critical

Capital spending is the one major part of the economy that has not performed as well during this recession/recovery period versus earlier ones. Indeed, capital spending was more negatively impacted this time than in any of the last six recession/recovery periods.

Nevertheless, there is a bright spot for future investment. Business investment in information-processing equipment and software has risen at a 9% pace in the first half of the year. This component is a critical one, since it fell 10% during 2001 and accounted for 40% of the drop in total business investment during the year.

Trade Promotion Authority (TPA) Medium Term Growth Booster

The global economic recovery has roughly coincided with that of the United States - pushing our exports ahead at an 8% pace in the first half.

Trade has lowered costs and increased selection across the whole array of goods that consumers buy, boosting household discretionary incomes for a decade - a trend that will persist.

With TPA, prospects for the continued, permanent reduction of global trade barriers through future trade agreements are greatly enhanced. Although not a short-term stimulus, future free trade agreements will increase trade, productivity, average real wages, and incomes in the United States and the world. By one estimate, reducing existing trade barriers by only a third could increase Americans' average family income by $2,500/year.

Further, the recent decline in the dollar's value will, with a lag, push the current cyclical drag from trade toward a plus.

Overview

The bottom line is that much about this economy is positive and moving in the right direction. Both monetary and fiscal policy acted to limit the severity of last year's downturn. Private forecasters as a group anticipate 2.8% growth for the second half, with some much more upbeat. Concerns remain: sufficient jobs are not yet being generated by the economy, energy prices are hanging at high levels, and worries linger about terrorism and a potential war with Iraq.

That is why both ends of Pennsylvania Avenue should work together to put people back to work, pass terrorism insurance, make the tax cuts permanent, enact an energy bill, and employ fiscal discipline in the budget process.

The President's leadership on tax cuts, the stimulus bill, and trade, coupled with sound monetary policy, continues to have a growth-inducing effect. I have confidence, based on the lessons of history and the signs of the present, that our economic future is indeed bright.