Vogelstein & Cowan: Bullish on November

Posted April 5, 2010 at 11:48am

It is becoming clear that progressives need to lay the groundwork to claim success. No, not on health care — the benefits of which may take years to realize ­— but on the economy.

[IMGCAP(1)]Based on a wide range of economic statistics, including last Friday’s sunny jobs report and the less publicized household employment survey, we conclude the following: While many people in Washington, D.C., underestimated the severity of the downturn, they are now underestimating the potency of the recovery. We expect gross domestic product growth to be above 3 percent in the first quarter and near 4 percent in the second, rather than the 2.5 percent now forecasted. Monthly job creation numbers this year will average closer to plus 200,000 than net zero. And by November, the unemployment rate will be closer to 8.7 percent than the current 9.7 percent.

We are not writing this to get Washington elected officials to invest capital in the market, but to invest their political capital into the courageous decisions they have already made. The past six months of economic data indicate that the widely vilified Troubled Asset Relief Program, Term Asset-Backed Securities Loan Facility and Recovery Act managed to thread the needle in the midst of an economic hurricane.

This was not foreordained. President Barack Obama and a Democratic Congress (and yes, President George W. Bush in his final months) had to reject the conservative market theologians’ implorations to “let ’em fail” and let the market sort things out. They had to push back against loud liberal calls to nationalize many of the largest banks and to spend an additional trillion dollars on short-term stimulus. Had they followed either of these courses, the country’s economic woes would certainly be far worse today.

Instead, they went bold, but moderate. Despite cries of profligate spending on the right and timidity on the left, the size and contours of the $800 billion Recovery Act were about right. They front-loaded the package with tax cuts, unemployment insurance and aid to states in the first year to put money in people’s pockets; they reserved the second year for job creation projects to put a floor on unemployment.

The real creativity came with TARP, TALF and other Treasury actions to influence monetary policy in ways heretofore never imagined. Immediately following the collapse of Lehman Brothers, investors fled the market and speculators bet large sums of capital on a downward spiral, accelerating the downturn and making credit scarce. The cost of borrowing for business skyrocketed so that by December 2009, the gulf between the interest charged for an investment-grade short-term loan versus a risk-free Treasury note was the widest since the 1930s. To put that into perspective, the spread implied an astonishing 30 percent default rate on short-term business loans, according to Robert Barbera, chief economist at Investment Technology Group and author of the “The Cost of Capitalism.”

With the cost of money so high, businesses had little resort but to panic. They hoarded cash by ceasing to produce new goods, massively drawing down inventories and slashing employment. By late 2009, inventories reached levels not seen in the modern age, and we all know what has happened with unemployment.

But the federal government stepped in by going beyond traditional Federal Reserve actions to influence monetary policy. To combat speculators short-selling the American economy, the Obama administration and the Federal Reserve pumped $1 trillion of liquidity into the money supply. They funneled $700 billion to prop up ailing banks in order to get credit moving. They forced banks to open their books so that investors could see that their toxic loan portfolio often wasn’t as bad as feared. They backed up securitized mortgages guaranteed by Fannie Mae and Freddie Mac to keep the housing market from imploding.

Last year’s panic has long subsided — replaced by stellar fourth-quarter growth, bank balance sheets approaching normal and TARP money mostly paid back. Unemployment has plateaued.

However, many economists still predict a meek and jobless recovery. But based on the current economic numbers, a meek recovery is almost impossible, according to Barbera. Never has inventory been drawn down close to this much without a substantial rebound. Rarely has productivity shot to levels reached in the last three quarters of 2009 without strong job growth following. Temporary employment has experienced six consecutive months of solid gains, as has the average hourly work week — both precursors of job growth. And the Bureau of Labor Statistics monthly survey of households indicates that a muscular 1.1 million jobs were added in the first three months of this year. The actual new jobs figure likely falls in between the sizzling household survey number and the tepid payroll figure extrapolated from surveys of established businesses. But what this adds up to is that employment figures are certain to be revised upward throughout the year.

The economy after a long recession is like ivy. First it sleeps, then it creeps, and finally it leaps. We’re in leap mode right now. But we would not be here without the extraordinary courage of Washington to reject the panicked calls and rash solutions of those on the left and the right. With better days around the corner, Washington leaders ought to take credit and, to quote Ronald Reagan, implore Americans to “stay the course.”

John Vogelstein is chairman-elect of the board of trustees of Third Way, a Washington think tank. Jon Cowan is Third Way president.