A consensus seems to be developing that the US economy is slowly improving, with economic growth right around the corner. President Obama exudes optimism. So does Wall Street. Even Paul Krugman, Dr. Gloom and Doom, sees a growing economy later this year.
While things are not as bad now as they were earlier this year, too many people have become subject to the "Been Down So Long It Looks Like Up To Me" syndrome (to borrow a title from wonderful Richard Farina novel).
Several forces make a recovery unlikely this year and point toward a larger contraction in the third quarter compared to the second quarter.
First, gasoline prices are up significantly since April. Some of this will benefit domestic producers, generating incomes for Americans. However, imports account for 60 percent of US oil needs. Most of this is functions like a tax on American households. As we send more and more money abroad, the domestic economic will suffer.
Second, state and local governments face severe financial crises. As the US economy sank, their tax revenues plummeted while their spending obligations (such as unemployment insurance and the state portion of Medicaid payments) increased. Unlike the Federal government, by law virtually every state and local government must balance their budget annually.
According to the Center on Budget and Policy Priorities, a Washington think tank, state governments were on course to be $133 billion in the red for fiscal year 2010, which began July 1 in most states. Unlike the Federal government, they cannot just run deficits to finance current expenditures.
The result is higher state taxes ($1 more for a pack of cigarettes in Florida, large sales tax increases in California, Massachusetts and Nevada, and eliminating property tax rebates in New Jersey), sharp spending cuts and worker furloughs for state employees, and higher fees for government services (mass transit hikes and higher motor vehicle license fees).
Local governments face similar financial problems. They too must cut wages, cut employment, cut spending and raise taxes.
Third, as part of the economic stimulus bill, the Federal government sent social security recipients, SSI recipients, and veterans a check for $250. The total spending for this portion of the stimulus package was $14.2 billion. A good part of this money was likely spent in the second quarter adding to economic growth (or reducing our economic decline).
But for the third quarter, these households will all have $250 less money and so there will be a good deal less spending taking place.
Fourth, consumers are hurting badly. They are saddled with enormous debt, accumulated over the past several decades. At the same time, unemployment is heading toward 10 percent while wages are stagnating.
Under these circumstances it would be surprising if consumers increased their spending. Instead, belts will be tightened. Any extra cash will first go to reducing debt and accumulating savings. The retail sales figures, released by the government yesterday, confirms that consumers are spending less. Despite the success of "cash for clunkers" retail sales fell in July.
Finally, and probably most serious, homeowners are ARMed and dangerous. Beginning last month, and extending through most of 2010, there will be a sharp rise in adjustable rate mortgages resets.
With so many homes already worth less than their mortgages, homeowners will be unable to refinance their loans. Nor will they be able to make higher payments when their mortgage rates reset. The result will be further drops in home prices, more foreclosures, more problems for large financial institutions, and a greater reluctance by banks to lend money.
There is something to be said for optimism. To be sure, this is a necessary ingredient for recovery. But optimism alone will not lead to an economic recovery when so many forces are pushing us further into recession.
We need another stimulus plan.