It’s time to worry about the economy, and that’s not just because they call economics the dismal science.
The reason is because there is a lot to be concerned about. All is not well with the economy, despite the stock market surge since the election last November.
Credit problems lie ahead. If we learned nothing else in the financial crisis of 2008 it is that credit is what makes the business world go around. It’s the grease that lubricates the wheels of capitalism. And that’s one place where the stresses are starting to show.
“I see both tightening lending standards in consumer credit and weakening demand,” says John Silvia, chief economist at Wells Fargo in Charlotte, North Carolina. “It’s hard to reconcile a pick-up in growth with no credit growth.”
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Weakening demand and tightening lending standards were noted in the January Federal Reserve Board Senior Loan Officer Survey. It is a really bad combination. It means that people who do want a loan will find it harder to get one. The weaker loan demand isn’t good for economic growth, either.
Silvia also worries about whether the economy is resilient enough to deal with the Fed increasing the cost of borrowing money, as it is widely expected to do later this year.
“Can the housing market withstand it and can small business?” he asks. He notes that many small business loans are priced off a variable interest rate known as LIBOR, the London Interbank Offered Rate. It’s the amount at which banks lend to each other. As the Fed increases the cost of borrowing the LIBOR cost increases also. Ultimately, the rising interest costs will cut into profits, which typically isn’t good for economic growth.
Small businesses are being cautious. “The rapid rise in small business and consumer confidence appears out of line with retail spending and with small business spending on equipment,” Silvia says. “That really does bother me.”
For instance, the National Federation of Independent Business’s small business optimism index hit 105.3 in February, up from 94.4 in August.
Yet the same survey shows that the percentage of small businesses planning a capital expenditure in the next three to six months fell to 26 percent in February versus 28 percent in August.
Put simply, if small businesses really were as optimistic as they say they are, why aren’t they splurging on new equipment?
Truly optimistic business owners would be spending on equipment so that they could prosper from any forthcoming acceleration in growth. The fact that the number planning to do so has dropped speaks volumes. Of course, that could change.
Car inventories are growing. Slowing sales of automobiles is a problem. Sales of cars and light trucks fell to an annualized rate of 16.62 million in March from 18.43 million in December, according to the Commerce Department.
Meanwhile, unsold cars and trucks keep piling up in inventories, says Joe Brusuelas, chief economist at professional services firm RSM in New York. “This implies a deteriorating U.S. manufacturing conditions and a slowdown in auto manufacturing,” he says.
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The reason is simple. Car makers don’t want to produce more cars when they already can’t sell the ones that they’ve made and that are now sitting in dealer showrooms.
While the auto business isn’t what it once was, it is still important.
Reduced output from automakers such as General Motors Co, (ticker: GM), Ford Motor Co. ( F) and Fiat Chrysler Automobiles ( FCAU) would be a bad thing the economy.
“Auto production plays an outsized role in movements in quarter-to-quarter GDP growth,” Brusuelas says. Automobile production involves many important suppliers including the makers of steel, glass, plastic, paint, rubber and copper. While a few individual companies get to stick their brand name on a car, there are many corporations involved. In other words, a car industry slowdown isn’t just a slowdown for auto companies.
If the slowing sales continue for more than a short period it would also be bad for the stocks of automakers and their suppliers.
There are investment problems. “I’m worried about corporate investment spending,” says Constance Hunter, chief economist at professional services firm KPMG in New York. “It was negative for last year.”
Private non-residential fixed investment (PNFI) declined for the first three-quarters of 2016 and then had a modest uptick in the final quarter, according to data from the Federal Reserve Bank of St. Louis. PNFI includes factory buildings, machinery and other things needed for production. It does not include single family homes or apartments.
Hunter says last year’s drop is a problem because investment in new technology and capital equipment increases productivity. So when spending on equipment falls it is a bad omen for the future of the economy.
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“It’s not very strong and that worrying because that’s where we get future productivity.” she says. No investment equals no productivity growth.
While productivity might seem like an abstract idea it is actually a key component in overall economic growth. In very simple terms, an economy will grow as much as its population grows adjusted for growth in output per person (a.k.a. productivity growth.)
If you have both fast productivity growth and fast population growth, then the economy will growth fast. Unfortunately, the U.S. has slow population growth when compared to countries like India. That means productivity growth is even more important to the U.S. if the economy is to grow.
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4 Reasons to Be Worried About the Economy originally appeared on usnews.com
