A sharply slowing economy with 2.5 percent growth

[Luke_Wilbur]

A sharp slowdown in consumer spending and family spending on their homes, alongside slowing business investment and a widening trade deficit, resulted today in a surprising drop in the government’s estimated economic growth in the second quarter of this year.

 

The weak estimated economic growth rate of 2.5 percent is a result of the heavy indebtedness of America’s households and of policy decisions by the Federal Reserve to raise interest rates for two years in a row, which made the debt burden more cumbersome for America’s families. According to the government’s Bureau of Economic Analysis, economic growth in the second quarter is less than half the strong annualized 5.6 percent in the first quarter.

 

This decline in the economic growth rate in the second quarter continues a longer term trend of a slowing economy. Year-on-year growth in the second quarter was 3.5 percent, down from 3.7 percent in the first quarter and a far cry from the high of 4.5 percent for the period ending in the second quarter of 2004 (figure 1).

 

With interest rates rising, families have found it harder to maintain the steep pace of the real estate boom of the past few years. And no wonder: By the first quarter of 2006, the last period for which data are available, American households had amassed debt in the equivalent of a record high of 126.4 percent of their disposable income.

 

In the second quarter of 2006, residential fixed investment, or families’ spending on their homes, declined by a stunning 6.3 percent in the second quarter of 2006, the third decline in a row and the largest decline since the second quarter of 1995. Compared to a year earlier, residential fixed investment was -0.2 percent lower than in the second quarter of 2005. This is substantially slower than the 6.1 percent growth from the first quarter 2005 to the first quarter of 2006 — nowhere near the growth rate of 13.7 percent between the second quarter of 2003 and the second quarter of 2004 (figure 2).

 

In the wake of a slowing housing boom, consumer spending growth for other items also appears on a downward trend. Consumers spent 2.5 percent more on an annualized basis in the second quarter than in the first quarter, down from an increase of 4.8 percent in the first quarter. Year-on-year consumer spending grew by 3.0 percent in the second quarter, compared to 3.4 percent in the first quarter and a high of 4.1 percent between the first quarter of 2003 and the first quarter of 2004 (figure 3).

 

With the American consumer less inclined to borrow, continued strong economic growth would have required more business investment. But with consumer spending slowing, businesses apparently have fewer incentives to spend their money on new plants and equipment. In fact, data from the Federal Reserve shows that non-financial corporations have been holding about 6 percent of their total assets in cash, the largest share since the mid-1960s.

 

Corporations’ reluctance to part with their cash is also reflected in the slowdown in business investment spending in the second quarter of 2006. Business investment grew at a low rate of 2.7 percent in the second quarter – the lowest growth rate since the first quarter of 2004. As a result, the year-on-year growth rate for the second quarter slowed to 6.8 percent in the second quarter, down from 7.4 percent in the first quarter of 2006 (figure 4).

 

Nor are the remaining sectors of the economy picking up the slack. Government spending was essentially flat in the first quarter with an annualized increase by 0.6 percent as spending by the federal government declined by 3.4 percent and spending by state and local governments grew by 3.0 percent. And foreigners are not buying U.S. products either. The trade deficit expanded again relative to the size of the economy.

 

To revive U.S. economic growth in the U.S., consumers need to find a way to raise their spending without going deeper into debt. This can only come about if more jobs are created and workers see real wage gains. At least in this case, today’s figures provide some hope that the labor market may be on the way to a stronger recovery.

 

Total inflation-adjusted amount of wages and salaries were 3.4 percent higher in the second quarter of 2006 than in the second quarter of 2005. This is the second time in a row that the year-on-year growth rate expanded and it is the highest year-on-year growth rate of this business cycle, which started in 2006 (figure 5).

 

The critical question, though, is if these apparent, albeit small, improvements can be sustained in the face of a Federal Reserve determined to slow the economy through higher interest rates, especially in the face of continued rising inflation. Without a revival of consumer spending on consumption and homes, though, the economy could find itself in this apparent slowdown for some time to come.

[Guest Joannou]

Warren Buffet saw it all. All we had to do was read his Suess like tale.

 

as head of Berkshire Hathaway, I am in charge of investing its money in ways that make sense. And my reason for finally putting my money where my mouth has been so long is that our trade deficit has greatly worsened, to the point that our country’s “net worth,” so to speak, is now being transferred abroad at an alarming rate.

 

A perpetuation of this transfer will lead to major trouble. To understand why, take a wildly fanciful trip with me to two isolated, side-by-side islands of equal size, Squanderville and Thriftville. Land is the only capital asset on these islands, and their communities are primitive, needing only food and producing only food. Working eight hours a day, in fact, each inhabitant can produce enough food to sustain himself or herself. And for a long time that’s how things go along. On each island everybody works the prescribed eight hours a day, which means that each society is self-sufficient.

 

Eventually, though, the industrious citizens of Thriftville decide to do some serious saving and investing, and they start to work 16 hours a day. In this mode they continue to live off the food they produce in eight hours of work but begin exporting an equal amount to their one and only trading outlet, Squanderville.

 

The citizens of Squanderville are ecstatic about this turn of events, since they can now live their lives free from toil but eat as well as ever. Oh, yes, there’s a quid pro quo — but to the Squanders, it seems harmless: All that the Thrifts want in exchange for their food is Squanderbonds (which are denominated, naturally, in Squanderbucks).

 

Over time Thriftville accumulates an enormous amount of these bonds, which at their core represent claim checks on the future output of Squanderville. A few pundits in Squanderville smell trouble coming. They foresee that for the Squanders both to eat and to pay off — or simply service — the debt they’re piling up will eventually require them to work more than eight hours a day. But the residents of Squanderville are in no mood to listen to such doomsaying.

 

Meanwhile, the citizens of Thriftville begin to get nervous. Just how good, they ask, are the IOUs of a shiftless island? So the Thrifts change strategy: Though they continue to hold some bonds, they sell most of them to Squanderville residents for Squanderbucks and use the proceeds to buy Squanderville land. And eventually the Thrifts own all of Squanderville.

 

At that point, the Squanders are forced to deal with an ugly equation: They must now not only return to working eight hours a day in order to eat — they have nothing left to trade — but must also work additional hours to service their debt and pay Thriftville rent on the land so imprudently sold. In effect, Squanderville has been colonized by purchase rather than conquest.

 

It can be argued, of course, that the present value of the future production that Squanderville must forever ship to Thriftville only equates to the production Thriftville initially gave up and that therefore both have received a fair deal. But since one generation of Squanders gets the free ride and future generations pay in perpetuity for it, there are — in economist talk — some pretty dramatic “intergenerational inequities.”

 

Let’s think of it in terms of a family: Imagine that I, Warren Buffett, can get the suppliers of all that I consume in my lifetime to take Buffett family IOUs that are payable, in goods and services and with interest added, by my descendants. This scenario may be viewed as effecting an even trade between the Buffett family unit and its creditors. But the generations of Buffetts following me are not likely to applaud the deal (and, heaven forbid, may even attempt to welsh on it).

 

Think again about those islands: Sooner or later the Squanderville government, facing ever greater payments to service debt, would decide to embrace highly inflationary policies — that is, issue more Squanderbucks to dilute the value of each. After all, the government would reason, those irritating Squanderbonds are simply claims on specific numbers of Squanderbucks, not on bucks of specific value. In short, making Squanderbucks less valuable would ease the island’s fiscal pain.

 

That prospect is why I, were I a resident of Thriftville, would opt for direct ownership of Squanderville land rather than bonds of the island’s government. Most governments find it much harder morally to seize foreign-owned property than they do to dilute the purchasing power of claim checks foreigners hold. Theft by stealth is preferred to theft by force.”

 

1 America’s Growing Trade Deficit Is Selling The Nation Out From Under Us. Here’s A Way To Fix The Problem – And We Need To Do It Now. Warren E. Buffet, Fortune magazine, 10 November 2003

[Guest human_*]

First we had the internet bubble, then we had the housing bubble "They are not called bubbles for nothing".

 

When I invest my money, I take a practical point of view of investing "Invest in those products to every one uses".

 

Military tents, shoes, electronics, medicines, wheelchairs, Oil Rigs <~ better put, the companies that make the oil rigs, life boats; Products that people need all of the time.

 

I like the orange book that the fda puts out because that one tells me which companies make which drugs "It's a nice little guide to follow". :)

 

 

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Warren Buffet saw it all. All we had to do was read his Suess like tale.

[Guest U.S. Senator John McCain]

There is nothing more important than keeping alive the American dream to own your home, and priority number one is to keep well meaning, deserving home owners who are facing foreclosure in their homes. I am pleased that the Congress is considering bi-partisan reforms to help the mortgage crisis. Bipartisan efforts may not make for great political theater, but they remain the most effective way to address quickly our nation's problems. Bipartisan efforts are also sometimes less than perfect, and I believe we can improve on the legislation before Congress.

 

I've made my principles in this area clear: Tax breaks for builders, funds to purchase homes in foreclosure, and tax credits that are not targeted to where the need is greatest do not constitute the federal help that is warranted. In some case, lenders and borrowers alike were caught up in the speculative frenzy that has harmed the housing market. And it is not the responsibility of the American public to spare them from the consequences of their own bad judgment. The goal should be to help homeowners who are struggling, and only about $5 billion of the bill addresses their concerns in any way. I believe we can do better.

 

We can also encourage groups like Neighborworks America and others provide mortgage assistance to homeowners in their communities. And our government can give them the resources to expand their efforts. I also believe that the mortgage lending industry has an obligation to help refinance mortgages. If what I have read about industry-led efforts is true, it appears that a stronger effort could be launched.

 

I believe a more robust, timely and targeted effort is my HOME plan. It offers every deserving American family or homeowner the opportunity to trade a burdensome mortgage for a manageable loan that reflects the market value of their home. This plan is focused on people. People decide if they need help, they apply for assistance and if approved the government under my HOME Program supports them in getting a new mortgage that they can afford. There will be qualifications which require the home to be a primary residence and the borrower able to afford a new mortgage. We will combine the power of government and the private sector to find immediate solutions for deserving American homeowners.

 

My plan follows the sound economic principle that when markets decline dramatically, debts must be restructured. It is built on the reality that homeowners should have an equity capital stake in their home. Homeowners would end up with a 30-year mortgage and an equity stake in their home. The new lender would receive a federal guarantee of the mortgage. And the taxpayer gets a benefit if the sale value ever recovers.

 

The result is a restructured financial arrangement for the homeowner. Over the long term, financial institutions must follow suit, writing off losses, restructuring their balance sheets, and raising more capital.