The recovery is loosing steam

What’s at stake: Until this year, the words “double dip” were most associated with a famous “Seinfeld” episode in which George Costanza puts a half-eaten chip back into the cocktail dip at a party. Now, especially after this week’s alarming numbers, they stand for a far less amusing idea: a return to recession. While that’s not a consensus forecast among economists, both the data and the gloom pervading financial markets suggest that the current recovery will be a long, painful process.

James Politi talks on the FT Money Supply blog of a triple whammy of bad US data. July 1 was a rough day on the economics beat in Washington. Rough in terms of America’s hopes for a strong economic recovery, that is. Let’s recap. At 8.30am, the labour department released its weekly jobless claim figures outlining that the labour market outlook is not rosy. Then, at 10am, a double punch in the face. The ISM manufacturing index dropped a lot more than expected in June, suggesting that one of the bright stars of the recovery is beginning to fade. Most economists knew that after inventories were restocked, there would be some loss of momentum. But the components of the survey were pretty horrendous, with the employment index falling as well as new orders from both the US and abroad. In addition, the prices index took a big plunge – perhaps a sign to Federal Reserve officials that disinflation is a very real threat. Meanwhile, the pending home sales index nearly collapsed in May, falling 30 per cent compared to expectations of a smaller 12.5 per cent drop on the back of the expiration of the homebuyer tax credit in April.

James Hamilton continues to see an economy that is growing, albeit significantly more slowly than we would have wanted. As reported by Steven Blitz of Majestic Research, adding 83,000 private US sector jobs, of which 20,500 are temporary positions, and losing 10,000 state and local government positions, is not the stuff of robust recovery but it also isn't the makings of a double dip. Historically, a deep recession would usually be followed by a sharp recovery. What's different this time? Bill McBride notes that it's harder to recover from a collapsed credit bubble, and two key drivers of many post-war recession recoveries – lower rates from the Fed and resurgence in the housing sector – are not going to help us this time.

Calculated Risks looks at absent engines of recovery. Usually the engines of recovery are investment in housing (not existing home sales) and consumer spending. Both are still under severe pressure with the large overhang of housing inventory, and the need for households to repair their balance sheet (the saving rate will probably rise — slowing consumption growth). It is hard to have a robust economic recovery without a recovery in residential investment — and there will be no strong recovery in residential investment until the excess housing supply is reduced substantially. During previous recoveries, housing played a critical role in job creation and consumer spending. But not this time. Residential investment is mostly moving sideways.

Casey B. Mulligan notes that double-dip recessions have occurred in the past. The severe 1981-2 recession began only a year after the 1980 recession ended. The Great Depression of the 1930s also came in two phases: 1929-33 and 1937-8. The first phase of this recession seemed to end in 2009, when real gross domestic product and employment stopped falling in the second half of the year. It is certainly possible that in 2010 we will see a quarter in which real G.D.P. falls a bit. Measured G.D.P. increased so sharply at the end of 2009, with hardly any improvement in the labour market, that economists have been suspicious that real G.D.P. was overstated.

Paul Krugman writes that we are now in the early stages of a third depression. Neither the Long Depression of the 19th century nor the Great Depression of the 20th was an era of nonstop decline — on the contrary, both included periods when the economy grew. But these episodes of improvement were never enough to undo the damage from the initial slump, and were followed by relapses. This third depression will be primarily a failure of policy since governments have become obsessed about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending.

Mohamed El Erian writes that the G20 gathering has failed to mark a much needed turning point for a slowing global economy with persistently high unemployment in industrial countries. Instead, it reinforces the concern than we are in for a future of muted growth, deleveraging, periodic debt dislocations in some countries, and higher protectionist pressures.

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