Ake’s Take: Who Let the Economic Dogs Out?

By | May 2, 2017

The Great Recession was devastating to the U.S. economy. At its worst point, 9 million people were unemployed and the average household income fell more than 8%. In addition, the U.S. government took drastic action to prevent the financial system from collapsing.

The people hurt the most by this recession were the risk-takers. There were many of these, because money was cheap and the economy was hot. Of course, we remember the “bad” risk takers: the house flippers; the guy who built a big hotel on a street already lined with hotels. However, there were also many “legitimate” risk takers: the service company that bought new equipment and vehicles to expand its business; the manufacturing company that built a new plant because of higher sales.

Unfortunately, the recession did not discriminate. If you had taken on too much risk at the wrong time, you might be finished. My friend, Steve, left his corporate job in the early oughts (00) to become a consultant, the risk being giving up a steady paycheck for potential greater reward. He worked hard and, over several years, had built a successful enterprise. I admired his entrepreneurship, risk-taking, and results. Then the Great Recession hit and virtually dried up almost all of his revenue.

After “average” recessions, businesses would soon begin spending and hiring again, albeit at a reduced rate. Consumers would promptly resume consuming. This would create a snapback in GDP, and we would be on our merry way until the next downturn. However, after the Great Recession this did not happen, and there never was a snapback. Everyone was afraid that the financial system could fail and make things even worse. A spirit of economic cautiousness permeated our culture, both for businesses and consumers. People saw what had happened to the risk takers and became very risk averse.

People did not buy lots of new homes. People did not buy many new cars. People drove their old cars fewer miles (it took five years to get back to the prerecession miles-driven high). Businesses did not hire people back. It takes more employees to build up sales than it takes to maintain sales. If a company is content with its sales volume, it does not need to hire additional workers. If a company has a growth strategy, then it needs more people, but this would involve taking risks. Most importantly, people did not start many new businesses, because that is one of the biggest risks you can take. Since successful new companies are a reliable source of new jobs, this also hindered employment growth.

Under more normal conditions, Steve’s customers would have started issuing contracts again. However, the services he provides are in some way related to taking normal business risks, so his clients didn’t  come back even though the recession was over. Steve took a teaching job to get a steady, but much lower, paycheck. He still consults, but that income is a small fraction of what it once was, even after eight years!

The risk aversion has become part of our culture. When companies see other companies or competitors take risks, they are much more likely to take risks. Millennials witnessing the economic destruction of the Great Recession don’t want mortgages or even car payments, knowing that if financial disaster hits, they just need shelter and food to survive. The 2012 presidential election is a notable example. Even though economic growth was sluggish, voters overwhelmingly chose the status-quo over the “risky” candidate who might make disastrous changes.

All this risk aversion had a deleterious impact on the economy. I know now, due to the great benefit of hindsight, there was too much caution. If people had actually taken normal risks, the economy would have recovered faster and stronger. If the economy had grown just 50 basis points more each year from 2010 to 2016, imagine how much better things could be right now.

There were signs that risk aversion was fading in 2016: more business startups, more job growth, more houses built. Yet, this still did not lead to a higher GDP. The economy seemed destined to remain in the doldrums, until an unexpected event suddenly created unbridled optimism, signaling it might be time to resume “normal” business activity and take some risks. If someone was just watching the confidence survey results in a vacuum, they would ask: Who let the dogs out? Who? Who? Of course, we know the answer is President Trump, however, remember this was a political event, not an economic one.

Now the dogs are running around and barking enthusiastically, but are they going anywhere? My good friend, Miles, says the animal spirits of the economy have been released. He reports that the Precision Machine Products Association (PMPA) Sales Sentiment Indicator, “exploded up 40% from December’s already optimistic number.” This index is significant, because these parts go into a wide variety of manufactured products. A manufacturing executive said, in a recent nationally televised town hall, “There is optimism and excitement (in corporate America), more so than ever before.”

Now the big question: How much of this optimism will actually turn into profit? Where is the action? Where are the tangible gains? Well, I don’t have information on the entire economy, but I do have clear insight into the transportation equipment market. There has been a sizable increase in orders since the election. The truck and trailer manufacturers increased production significantly in March, and Class 8 truck OEMs are expected to continue to increase production throughout the year.

There is still reason for some caution, however, in that many of the orders placed are for delivery in the second half of the year. Fleets are showing strong confidence in the future sales, which is consistent with all the sentiment surveys. However, this also is a positive sign for the general economy, since commercial equipment is a solid economic indicator (you need to have more equipment ready to haul the increased freight generated by a growing economy). More truck and trailer orders would point to a strong economy later this year.

If being cautious knocked 50 basis points off GDP, what does this burst of optimism add? Does it just turn that around, adding 50 points? Does it cancel that out and add the same amount back on, a 100-point increase? Most economists don’t expect this confidence and risk-taking to have much of an impact this year. It is difficult to adjust a forecast based on those darn animal spirits. I made that mistake in a previous post, believing that the optimism would significantly impact Q1 GDP, which limped in at a meager 0.7%. Q2 is forecasted to be much better, however. It will be interesting to see how fast those economic dogs are running in the second half of the year.

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About Don Ake

Don has more than 20 years of experience in the transportation industry, including 16 years with industry supplier Hendrickson International. Don has a very strong forecasting and market analysis background. While at Hendrickson Don developed forecasting models, methods and processes to accurately forecast Truck and Trailer builds and product demand. Don wrote an industry economic newsletter and gained a reputation as a top industry analyst. His industry supplier background provides a "customer perspective" now that he is with FTR.