Economist.com: Still on the Right Road

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Link:

http://www.economist.com/finance/displayStory.cfm?story_id=11850301&source=features_box_main

America's economy

Still on the right road

Jul 31st 2008

From Economist.com

America’s economy has steered clear of recession so far. How long can it keep growing?

THE American economy has often defied predictions of its demise. It has done so again. Official figures published on Thursday July 31st show that America’s GDP rose at an annualised rate of 1.9% in the second quarter. This would a respectable enough growth rate at the best of times. That this was achieved despite the considerable handicaps of a badly damaged banking system, a big jump in oil prices and the ongoing housing bust, makes it remarkable.

Revisions to earlier quarters took some of the shine of the news. Government statisticians now reckon that the economy shrank in the final three months of last year: the annualised change to GDP was revised from 0.6% to -0.2%. But growth picked up slightly to 0.9% in the first quarter, so on this reading at least, America seems to have just steered clear of a technical recession—two consecutive quarters of contraction.

One reason why the economy has held up well is that the weak dollar has encouraged exports and curbed imports. American firms have been kept going by foreign sales during a period in which domestic spending has been somewhat hampered. In the two years since the housing bust started in earnest, the contraction in homebuilding has taken around one percentage point a year of GDP growth. That drag has been more or less fully offset by the boost from net trade. In the second quarter, exports net of imports accounted for all and more of the increase in GDP.

Spending at home has held up rather better than might have been expected, as well. Consumer spending picked up speed in the second quarter, lifted in part by the $86 billion of tax-rebate cheques that were sent out between the end of April and the start of July. The homebuilding industry shrank again, but at a slower rate than in previous quarters, and the dampening effect on the economy was partly offset by a big increase in the construction of commercial buildings.

The economy’s resilience, while remarkable, cannot be relied upon to last. Export growth is likely to soften, because America’s trading partners in the rich world are now struggling too. GDP growth in the euro area is grinding to a halt and Britain is teetering on the brink of recession. Japan’s economy may be flirting with one too.

Spending by American firms and households is also likely to soften. If consumers relied heavily on tax rebates to keep their spending going in the second quarter, there will be less cash left over to shell out in the coming months. And the lifeline provided by home-equity loans is increasingly constricted, as damaged banks cut back on pre-arranged credit lines. Firms will be more circumspect about investing—even if they could secure funding for big projects—if spending at home and abroad is set to turn down.

The Federal Reserve’s rate-setters, who meet on August 5th, have already bumped up their forecasts for GDP growth this year, because of the economy’s unexpected resilience. Some Fed officials are uncomfortable that interest rates are so low when headline inflation is at 5% and the economy is still growing at a decent rate. Yet most are still more concerned that the economy could yet nosedive as credit becomes scarcer. For that reason, the Fed is widely expected to keep interest rates on hold, at 2%, for a second successive meeting.

Despite these worries, the economy may still avoid a contraction in coming months, if only because American firms have run down their stocks so aggressively. GDP rose at an annualised rate of almost 4% in the second quarter, if the impact of reducing stocks is stripped out. If firms rebuild their inventories, or even stop slashing them, this will give GDP growth a big lift in the current quarter. Which means, the long-awaited American recession might still be some way off.

Amidst discussion of whether the economy is doomed to recession or will bounce back like it usually does, I thought this article offers a pretty positive outlook for the rest of the year. Despite all the problems that we've had recently with subprime loans, the credit crisis, and the huge financial shake-ups, things are a lot better than they could've been.