A Distant Boom

It now seems pretty clear that the economy has hit bottom. In general, things aren't getting any worse and there are even a few signs that indicate that a turnaround is underway. However, the one question that hangs over all the talk of recovery is what sector of the economy is going to drive growth.

In the past couple of recoveries, spending by American consumers has lead the way out of recession. But--as story after story has made abundantly clear--it seems unlikely if we're going to see a repeat of that this time around. Consumers are literally tapped out. They've already taken on more debt than they probably should have and many Americans are now concentrating on getting their personal financial houses in order by reducing debt loads, saving more, and spending less. This newfound fiscal prudence is both understandable and praiseworthy. But it means that we should not be looking for consumers to carry the economy forward.

Another possible source of consistent growth is business spending. The dramatic manner in which companies pared their inventories, reduced their workforces, and cut costs in the wake of the downturn means that they are now running lean. With the worst economic news now seemingly behind us, it's likely that they will need to restock and open up the purse strings a bit just to keep up with the steady--albeit flat--demand they are now seeing. This will likely have somewhat of a rebound effect which will improve GDP numbers in the next couple of quarters. But what will businesses do after that to driven consistent, sustained growth?

An article in yesterday's WSJ asked Where Consumers Fail, Can Businesses Lead?:

What the economy needs now is a business spending spree that will lead to a hiring boom and rising consumer incomes.

Businesses clearly have the cash. In the first quarter, nonfinancial companies had some $14.1 trillion in financial assets, according to Federal Reserve data, or 100.1% of gross domestic product, a record high.

But after the 2001 recession, businesses accumulated cash, rather than spending it, because of the spending glut during the tech boom. They mightn't have much appetite for spending this time around, either.

They owned more than $4 trillion in equipment and software in the first quarter, about 29% of GDP, not far from the 30% that prevailed during the tech boom. Meanwhile, the nation's factories, utilities and mines in July ran at 68.5% of their production capacity, near a record low, giving them little reason to build out more capacity.

At this point, it isn't even clear that business spending will be strong enough to make the recovery self-sustaining. A business-led boom seems unlikely.

So we can't count on consumer or business spending to drive the next economic growth. What's that leave us with? Government? Keynesians would tell us not to worry. After all, most of the government stimulus money hasn't even been spent yet. Why, once that starts kicking in then the economy is really going to get humming again.

Even if you assume that most of President Obama's stimulus package will actually serve to stimulate the economy (a pretty dubious assumption), the problem with relying on such one-off government spending is that its impact is usually short-lived. If look at the factors holding back consumers and businesses from spending, it's hard to see how the stimulus package will serve to change behaviors with either group.

And with the latest news on the growing deficits and mountains of debt the Obama administration has already signed us up for, it's difficult to imagine a second stimulus package (Son of Stimulus?) being a realistic possibility. So once this wave of government spending washes over the land, the well is pretty much dried up.

Which means that we're probably looking at a best case economic recovery of slow growth, limited job creation, and constrained spending (at least by consumers and businesses). Better than being in recession, but not much to write home about. Worst case? A double dip with the economy falling back into recession again. No roaring or booming on the horizon.