Stable home prices key to thwarting deflation, double-dip recession

Deflation and an ensuing double-dip recession can be avoided if recently stabilized home prices don’t fall again, said Rajeev Dhawan, director of the Economic Forecasting Center at Georgia State University’s J. Mack Robinson College of Business.

In his quarterly Forecast of the Nation, released today, Dhawan said that the “D” word (deflation) is being heard more frequently because of factors such as the slowing of private job creation, yo-yoing retail sales, falling core CPI inflation (inflation excluding food and energy costs), and a rapidly falling 10-year bond yield, now below three percent.

“Consequently,” said Dhawan, “what happens to home prices over the next few months will be critical to consumer confidence. It will affect their spending decisions, especially for big ticket items. This, in turn, will send a signal to CEOs about whether or not to ramp up investment and hiring plans, which then will determine potential consumer income growth and, ultimately, the next round of spending.”

The importance of home price stability is also evident from the fact that one-third of the CPI Index derives from housing or shelter costs. Said Dhawan, “If we take shelter costs out of the core, there is no deflation. Hence, if home prices plunge again, spending power will be sapped, resulting in further price declines that will manifest as deflation leading to a double-dip recession.”

The good news, said Dhawan, is that the growth rate of investment in equipment and software, a precursor of job growth, has been in double digits for the past nine months. Sustaining that pace will depend, said the forecaster, “upon what happens with the currently polarized political atmosphere, costly unpopular reforms and high fiscal deficits causing uncertainty over the tax structure in coming years.

“Still,” Dhawan concluded, “the expectation that housing prices will rise only about 10 percent over the next five years (according to the July MacroMarkets home price survey) has kept consumer confidence flat, illustrating again why home prices are so critical to future growth.”

Highlights from the Economic Forecasting Center’s National Report

Real GDP growth in 2010 will be 2.8 percent for the year. Due to a rollback in government spending and subdued spending by consumers, it will decelerate sharply to 1.9 percent in 2011. In 2012, the real GDP will grow at an improved rate of 2.7 percent. Consumption growth will remain subpar throughout the forecast period, barely reaching 2.2 percent in 2012.
Inflation will be 0.8 percent in the second half of 2010, 1.3 percent in 2011, and will increase to 2.1 percent in 2012. Rate hikes will be on hold until late 2011. At that point the Fed will be aggressive with hikes, quickly raising the target rate to 3.0 percent by mid-2012, as core inflation gets closer to 2.0 percent.
Expect the 10-year bond rate to rise in the coming months to make for an average of 3.4 percent in 2010. It will rise further to 3.9 percent in 2011 and to 4.5 percent in 2012. The fiscal deficit will be 10.0 percent of GDP in 2010, moderating to 6.5 percent in 2012.
After growing by 14.3 percent in 2010, investment in equipment and software will decelerate to 10.1 percent in 2011. In 2012, the category will expand by 10.7 percent. Job growth will increase from the current pace of 100,000 in 2011 to 130,000 in 2012. Unemployment will remain consistently above 9.0 percent.
Georgia and Atlanta to Exhibit Quasi-Growth Prospects
Dhawan said that swings in the national economy, a cautious corporate sector and tempered consumer spending due to weakened prospects for increases in property values will lead to “quasi-growth” prospects locally.

In his Forecast of Georgia and Atlanta released today, he said that factors that reducing income potential going forward include yo-yoing retail sales, weak consumer confidence affecting business investment, and a lack of credit, particularly for smaller-sized corporations, due to continued fallout from the subprime crisis.

“The inability of banks to make loans continues to hamper construction at all levels,” said Dhawan, who added, “Big value projects are missing from the local growth picture. The same is true on the residential side, where many small developers are gone due to an inability to sell unfinished homes.” At the current permitting rate of about 6,000 annually, Atlanta has enough developed lots to build for the next 20 years, he said.

Despite this, housing permits have risen sharply in the last six months, “but only,” said Dhawan, “because people are doing major renovations rather than developers building big multi-family projects. Even with that,” he said, “actual permit levels are one-tenth of what they were at their peak in 2006.”

Things are not much better when it comes to government, which was hit hard in 2008. State government has seen some growth in collections due to a rebound in spending and tighter controls. At the county and city levels, however, the drop in home values has led to sharp declines in collections.

“The corporate sector,” said Dhawan, “has added jobs nationally in the last six months, but growth at the local level has been minimal.” In Georgia the sector has been aided somewhat by the opening of the Kia plant in West Point, the building of a new facility by NCR and, to a lesser extent, planned development of green-tech jobs.

Dhawan said to look for job gains in Atlanta to number only 3,700 for calendar year 2010. Job gains will rise substantially to 46,300 (including 13,800 premium jobs) in 2011 and 55,300 (14,300 premium jobs) by 2012. Unemployment rate, however, still remains above 9.0 percent even in 2012.

Highlights from the Economic Forecasting Center’s Local Report

Georgia will gain only 5,000 jobs in calendar year 2010. In the 2011 calendar year, the recovery pace will pick up somewhat with the creation of 60,300 jobs (including 18,100 premium jobs). Job growth will be stronger in calendar year 2012; 78,300 jobs will be created (with 17,200 premium job gains).
By year’s end, Georgia's unemployment rate will have increased modestly by 0.6 points to 10.2 percent. In 2011, unemployment will decrease slightly to 9.7 percent. In 2012, it will decrease further to 9.2 percent.
Atlanta's housing permits will increase in 2010 by a strong 39.9 percent, with both single and multi-family permits posting significant increases. Permit activity increases by 28.9 percent in 2011 and will grow by a robust 47.1 percent in 2012.
Nominal personal income in Georgia will rise by 3.0 percent in 2010, followed by an increase of 4.1 percent in 2011 and a decent increase of 4.8 percent in 2012. Georgia’s total tax collections are expected to increase by 3.5 percent in FY11, followed by another rise of 5.0 percent in FY12.

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The Conference Board Maintains That Global Growth Rates Are In Positive Territory

/PRNewswire/ -- The Conference Board reports yesterdaythat global output growth in 2009 will be slow but remains positive at 1.3% for 2009. As the G-20 gathers in London today, The Conference Board points at large discrepancies in the global economy this year, with advanced economies experiencing a strong contraction in output at -2.5% on average, and emerging economies pulling the world economy along at a reasonable pace of 5.0% on average.

"As projections of global growth have been slashed dramatically recently, we need to remain conscious of the huge uncertainties about how the decline in global trade affects the domestic sectors of emerging economies," says Bart van Ark, Vice President and Chief Economist of The Conference Board. "The internal dynamics of growth created by the millions of consumers in these countries, who have a job or are able to find a job, even in a slowing economy, will continue to generate positive growth." His analysis appears in StraightTalk, a newsletter designed exclusively for members of The Conference Board global business network.

MODEST RECOVERY IN THE U.S. REMAINS LIKELY

Real GDP in the United States is forecasted to fall by -5.9% on an annual rate during the first quarter of 2009, signaling a deep point in the recession. Some better numbers are beginning to emerge. The Conference Board Leading Economic Index and Consumer Confidence Index suggest that the recession will not intensify further. The decline in real consumer spending has leveled off a little. Retail sales, excluding cars and car parts, rose by .7% in February, and some turns in the measures of home sales and prices were also recorded. The Conference Board projects that growth in the second quarter will stay negative and will be very slow in the third quarter, as capital spending will remain low and inventories will not be depleted until year's end. Overall industrial production is also unlikely to move up before the fall. Even the recovery in the fourth quarter will be held back by these negative trends and increased unemployment, which is typically a lagging indicator.

The U.S. may see a contraction in real GDP of -2.6% in 2009 - the largest annual decline since 1946. Nominal output (the value of output that also reflects price change) may actually fall at more than 4%, as disinflation is much more likely in the short run than inflation.

RISK OF A "DOUBLE-DIP" RECESSION

Back-to-back recessions, as occurred between 1980 and 1982 when the economy endured a systemic crisis rather than a regular recessionary period, are a potential risk at this time. Recent increases in commodity prices, on the back of monetary easing and decline in the dollar, are leading to an increase in inflation expectations.

"If the United States experiences a too rapid recovery, there may be a risk of another recession in 2010," cautions Van Ark. "It may fuel expectations for a return to inflation, adding to the uncertainty concerning the pattern and path of economic recovery."

The likelihood of this happening is small as there are three substantial differences between the current crisis and that of the early 1980s: 1) Inflation was the concern then; now the possibility of deflation for the short and medium term is a greater threat. 2) The 1980s crisis was related to a structural transformation of the model of production in the U.S., moving from a manufacturing to a services economy; the current crisis was largely sparked by overleveraged balance sheets and global imbalances in consumption and savings. 3) This time we have massive governmental intervention intended to prevent economic activity from declining even further and stem the rise in unemployment.

LARGE DISCREPANCIES BETWEEN ADVANCED AND EMERGING ECONOMIES

The Conference Board argues that the divergence in growth performance between advanced and emerging economies will create a major challenge to rebalancing the world economy toward a more manageable global distribution of production, consumption and trade in goods and services.

The economies of commodity-producing countries - such as Russia and Brazil - have been producing bad results due to falling energy and commodity prices. China and India are the best bets to limit the global output collapse in 2009. China's export growth engine is under serious stress and the consumer sector will surely be affected by the decline in employment opportunities.

But the internal dynamics of growth created by the millions of consumers who still have a job or are able to find one in a slowing economy will continue to generate positive growth in China. Even though much of the U.S. $586 billion stimulus is likely to have already been baked into the government's investment plans, it may help keep China's growth rate at about 7.5% for 2009, says van Ark.

In India, as well as in several other large economies in the developing world that are somewhat less exposed to the global storm, the impact of the collapse in financial markets on fourth quarter GDP may have done a less lasting damage to the potential for growth this year.

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