Our Economy: Off Life Support but not out of Intensive Care

Personal Income flatlined in September, Third Quarter limped along at 2% Annual Growth.

Wells Fargo Economics reported today that changes in unemployment compensation legislation resulted in a reduction of benefits paid by $25.5 billion at an annual rate in September as third quarter results started to appear for the markets to digest. This explains most of the drop in personal income, coming on the heels of a $20.5 billion boost from unemployment insurance payments in August.   That means that other than transfer payments, income was flat in September, but is modestly positive compared to ‘depressed’ levels last year.

Does that make you feel better?

I didn’t think so.  Real GDP grew in the third quarter at a 2.0 percent annual pace, but that is not enough to bring down the unemployment rate. Much of the rise in GDP was due to an increase in consumer spending and inventory accumulation.

But as spending went up savings rates declined since income did not rise.  Does this sound like a dog chasing its tail?  Economists tell us the markets likely are watching the Fed’s Open Markets Committee for new clues about stimulus or other changes to try to improve growth.  The consensus is that the markets have already factored in a second round of quantitative easing of about $500 billion in Fed purchase of long term Treasuries over the next several months.  The bet is this will be enough to keep the economy growing albeit modestly, keep a little inflation in the mix to assure against deflationary complications and slowly continue the pull to get the bus out of the ditch.

Since the markets hate uncertainty they may actually like a humbling of the Democrats expected from the election but be glad  to see gridlock for a while instead of full Republican control of Congress—deadlock provides market certainty even if it is bad for the country.

Wells Fargo Securities Integrated Research and Economics released a report entitled, “A Congress Divided?” noting that the election could have historical significance as there has not been a Democratic president with a divided Congress in the past 100 years. More importantly, the potential for gridlock in the coming years could help reduce some of the policy uncertainty, which is welcomed in light of moderate growth projected through 2011.”

So what?

Third-quarter economic growth at a 2.0% annual rate is not enough for sustainable recovery. That is why the Fed is using other policy tricks to try to boost that growth rate.   Much of the increase in real GDP came from consumer spending and inventory accumulation increases but real final sales grew at a meager 0.6 percent.

The economists tell us that typically, at this stage in the recovery, as inventories are low, domestic demand picks up to restock the shelves in anticipation of faster growth ahead. But this time consumer unease over high unemployment rates means that we are paying down debt and not charging on our credit cards waiting for more confidence in the economy.  This vicious circle is what is slowing the recovery.

Add to that the housing hangover depressing us along with our home prices and the third quarter saw residential investment drop 29.1% as the Federal homebuyers’ tax credit ended in the second quarter. The consensus view is housing will take maybe another year to show clear signs of a turnaround because the overhand of so many foreclosed and foreclosable properties and the bank problems with “who’s your Daddy” questions over where is the note are sure to make many trial lawyers richer before the foreclosure mess is cleaned up.