August 27, 2003
Except for unemployment claims, nearly every economic
report in recent weeks not only showed strength for the reporting month, but
also indicated that previous months were stronger than originally reported.
Even the claims have been below 400,000 for four of the past five weeks,
but their revisions of previous weeks have tended to be upward.
My own calculations now suggest that the 2.4 percent growth
in GDP reported for the second quarter last month will be revised to 3 percent
growth or higher this month. Substantial
upward revisions in retail sales and housing activity as well as improving trade
balances for June suggest that such a revision is warranted.
Moreover, the July retail sales remained so strong that
consumer spending might grow as much as 5 percent at annual rates during the
quarter. Alone, this would
contribute more than 3 percentage points to third quarter growth.
The leading indicators showed strong gains for the latest
month and also were revised upward for the previous month. To the extent that these indicators can predict magnitudes as
well as direction of economic activity, the latest gains are consistent with 4
percent growth during the third quarter.
Of course, almost half the quarter remains. Thus, any estimates of activity must remain very premature. Still, this should be the strongest quarter for economic growth since 4 percent gains also surfaced in the summer of last year.
Which leads us to a concern. If this type of economic strength developed briefly a year
ago, could it be followed by the same period of job weakness that followed that
Indeed, the pessimists are citing the rapid increase in
fixed mortgage rates to suggest that housing will stall in only a few months.
They seem to forget that fixed mortgage rates also began rising in 1994
but home building remained strong. To
be sure, first time homebuyers were forced to abandon the safety of fixed rate
mortgages for adjustable contracts.
Today, the most popular form of adjustable mortgage is the
interest only contract. Indeed,
many homebuyers get a monthly payment that is even lower than the lowest monthly
payment available when fixed rates were at their lowest levels.
However, after a period of time, usually five years, the homebuyer will
need to refinance or pay off that mortgage, and rates could be dramatically
While such mortgage instruments certainly carry risks, they
also allow homebuyers to qualify for a home that they otherwise could not
occupy. Less risky mortgage
instruments than the interest only type were largely used in 1994, but the
housing market continued to prosper until short term interest rates rise.
Thus, those news commentaries that say the end of the
housing boom is here fail to understand that short term interest rates remain an
unusual bargain that still can keep new home buying going.
Of course, the higher rates end the refinancing surge.
Why refinance with interest rates that might even be higher than the ones
you closed on a year ago. This will
impact employment in financial institutions, which may have added 115,000 jobs
to handle mortgage applications in the past year.
Whether it also impacts the earnings of such institutions depends upon
how quickly costs can be shed to reflect the plunge in mortgage applications.
A second worry has been the recent rally in the dollar
against the euro. A worry is
justified, but not because the dollar once again is getting non-competitive.
Instead, the euro weakness is because most of euroland is in recession.
We will get few sales from them in any event until more expansionary
monetary policies are pursued there. (The
beginning of just such a change in policy was apparent last month, but more
needs to be done.)
A third worry is the continued high gasoline prices.
The blackout took two days of refinery production out of the oil
pipeline. This was enough to lose a
week's worth of inventory. The
result has been sharply higher gasoline prices.
The refineries are again working and supplies should begin to build.
Unfortunately, there is a legitimate energy worry.
Low production in Iraq and threats of cutbacks by OPEC at their September
meeting have kept energy prices very high.
Most market experts believe this is temporary and oil prices will fall in
the fall. However, unusual weather could negate this outlook.
A fourth worry is that high bankruptcies reflect an
over-extended consumer. In fact, it
reflects consumers taking more risks. The
high consumer debt actually needs a lower interest payment than at the end of
However, the only worry keeping me from declaring that a sustainable recovery has begun is the absence of jobs. Let's see how many new paychecks can be created in the next few months. If the answer is none or very little, then this surge also will fail. If the answer is 100,000 or more per month, then we are on our way to sustained expansion. The next few monthly employment reports will tell us what it will be.