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ECONOMY: Durable Goods Orders Jumped 1.3 Percent in July

Prof. Peter Morici - 8/27/2008

Today, the Commerce Department reported new orders for producer durable orders bounced up 1.3 percent in July. This confounded the more conservative estimates of forecasters�the consensus of prognosticators was for a 0.2 percent gain.

Orders for business equipment�nondefense capital goods less aircraft�were up 2.6 percent in July and were up an average of 1.2 percent over the last three months. This is a very strong showing, and reflects the bounce from a weaker dollar and exports, and efforts by industry to adapt to higher energy prices. However, with growth slowing in Europe, Japan, China, and elsewhere and the dollar recovering a bit, it is questionable whether export strength will continue.

June durable goods orders were revised up to 1.3 percent from 0.8 percent, and this is consistent with the strong upward revision expected in second quarter GDP growth.

Thursday, the Commerce Department is expected to revise upward estimates for second quarter GDP growth to about 2.7 percent from 1.7 percent. The latter figure was the advanced estimate issued on July 31. A smaller foreign trade deficit and some adjustments in the investment and inventory categories should also help lift the estimate for second quarter GDP growth.

Forecasters expect growth to slow by about a percentage point to something in the range of 1.5 percent in the third quarter. Consumer spending was propped up in May and to a lesser extent in June by the stimulus package tax rebate checks. The consensus forecast is for consumer spending to fall by 0.2 percent for July, while my forecast is for a very small gain of 0.2 percent. That data is due out Friday.

Weighing more heavily on third and fourth quarter growth will be the escalating credit crisis. Banks are entering a near perfect storm.

Mounting real estate foreclosures, bad construction loans and other real estate problems�more vacant stores and defaults on retailer lines of credit�will stress already limited bank reserves and dwindling capital.

Borrowing costs for banks are rising as they refinance large sums of floating rate notes�securities with a typical maturity of two years sold to large investors. Banks issued a lot of these in late 2006 and 2007 to paper over the mounting problems with subprime loans, and these are turning over at much higher premiums over Libor. Some banks may find they simply cannot get all the refinancing they need. More regional banks will fail, while large money center banks will get most of what they need and continue to lean on Federal Reserves special lending facilities.

Many large bank customers are tapping pre-negotiated lines of credit�that�s the �liquidity� boasted by low-risk clients like GM, Chrysler and other similarly sound companies. Worthy smaller businesses may have to do without loans or settle for less or very expensive bank financing as troubled giants in the Mid West union belt borrow yet again to pay gold-plated fringe benefits to those who are less productive than their rivals elsewhere in the United States and abroad.

If you are a homebuyer or business planning to visit a bank this fall, bring a thick hide and perhaps your spiritual advisor, because it all adds up to a tough time to finance a mortgage or new business investment.

All of this is aggravated by the fact that large money center banks are part of large financial supermarkets. Following the model fashioned down by Citigroup CEO Vikram Pandit, these giants are using the Federal Reserve�s special lending facilities to park bad paper, while deemphasizing commercial banking and looking at other higher profit activities like wealth management, mergers and acquisitions, and various forms of trading. Essentially, Ben Bernanke has propped up these institutions to keep them going as commercial banks, considered a function vital to the economy, and these financial giants are using the money to invest in noncommercial banking activities. This will only serve to slow growth and penalize better run businesses elsewhere in the economy.

Overall, tighter credit will further drive down home prices and slow growth in consumer spending, business investment and government capital projects. By my reckoning GDP will slow to about 1.5 percent in the third quarter and to near zero in the fourth.

The good news is the productivity growth remains strong, Americans remain creative and despite the foolishness at the banks, the economy will have a shallow recession and recover.