Economic Update: It Ain’t Pretty

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from TPM Cafe:


Economic Update: It Ain’t Pretty
By Jared Bernstein


There’s been a spate of economic reports of late sending out all kinds of disparate messages as to what’s going on in the current economy. Here’s one wonk’s view, ifyi (“if you’re interested”).

The big economic stories of the past few weeks are the stock market tumble, the status of underlying overall growth (as in real GDP, the broadest measure of the economy’s health), and the jobs situation.

After jumping around pretty madly all week, the major stock market indexes fell steeply last Friday, with the Dow down 2% and the Standard & Poor’s much broader index down 3%. The main driver behind all this skittishness appears to be the end of cheap credit. While some analysts have argued that “credit is drying up,” meaning that borrowers can’t find the capital they need to finance their deals, that’s wrong. There is still a lot of liquidity out there—dollars ready to be loaned and invested—but its price is rising.

As it should be. There were lots of big, bad loans made to inflate the now deflating housing bubble, and the risk involved with these loans was often underpriced. Some of those lenders, and not just the subprime crowd, are now losing their shirts and their businesses. In such a climate, risk premiums—the higher interest rate that borrowers have to pay investors for the use of their capital when returns are less certain—rise, deals take longer to make, and the volume and pace of such activities slow down. This may freak out the go-go markets, who have thrived on easy money generating lots of deals, mergers, buyouts, and trades. But it’s an absolutely necessary adjustment. An economy based on under-priced risk is a bubble economy, and bubbles are much more damaging than a lot of people seem to realize.

How is this financial market development playing out in the rest of the economy? Basically, GDP is running at about one point below trend, i.e., you’d like to see GDP growth between 3-3.5% per year, and it’s been at 2% for the first half of the year. Since 2006q2, the housing slump has reduced GDP growth by just under a percentage point per quarter, so there’s your trend zapper.

When GDP growth is below potential, it eventually leads to weaknesses in the real economy—the one you and I interact with everyday. Job growth slows, unemployment rises, and wages and incomes ultimately take a hit. .......(more)

The complete piece is at: http://www.tpmcafe.com/blog/coffeehouse/2007/aug/05/economic_update_it_ain_t_pretty