The U.S. economy is due for a "correction" or a "cooling off," rather than an outright collapse into stagflation or recession, according to Clare Zempel, Milwaukee’s foremost economist. Zempel recently founded Zempel Strategic in Fox Point after serving several years as the director of investment policy, chief investment strategist and chief economist for Robert W. Baird & Co. Inc. in Milwaukee. Zempel recently discussed his outlook for the economy with Small Business Times executive editor Steve Jagler. The following are excerpts from that interview.
SBT: Just about every economic indicator out there is pointing to a slowdown of some sort in the second half of 2006. Do you concur?
Zempel: "The word slowdown covers such a wide range of things. I see it cooling off. We’re talking about a decline in the level of housing activity. We’re talking about a slowdown, but not a collapse, in the growth of consumer spending. We’ll see negative surprises here and there, disturbing declines in home prices. It’s a question of the recent stock market weaknesses – is it a correction? Or is it telling us that the recession or stagnation argument is the correct one? In the late summer or early fall, there will probably be a sense of relief, that yes, things have slowed down, but there is no outright collapse."
SBT: So you don’t foresee a recession?
Zempel: "It’s not a recession. Recession is zero growth. So, some moderation of the economy’s growth rate, yes. A slowdown that approaches the level that causes widespread pain for businesses and individuals, no. The reason I don’t think the slowdown will be that deep in the overall economy … is that real interest rates, inflation-adjusted interest rates, are nowhere near where they were when past recessions occurred."
SBT: Which economic numbers are you really keeping your eyes on right now?
Zempel: "A couple of indicators that I watch to keep my pulse on the short-term pace of the economy is the interplay between commodity prices and unemployment claims. Generally speaking, when commodities prices are rising, the demand is strong, the economy is strengthening, it’s turning around or continuing to expand. Generally speaking, when unemployment claims, that weekly number, when that number is in a declining trend, that means fewer people are being fired and fewer people are being laid off. If you make a ratio out of them, commodities prices divided by unemployment claims, the interplay of those two numbers is hypersensitive to speed-ups and slowdowns in the economy. And there is no slowdown evident in that number yet, despite what is an undeniable downturn in housing in the economy."
SBT: But certainly, there are some dark clouds out there … The housing market and consumer spending …
Zempel: "I think in housing, we’re talking a decline in the level of activity. In consumer spending, we’re talking about a slowdown in the rate of growth. I readily stipulate that there are a lot of problems dealing with oil prices and other rising costs."
SBT: Residential property foreclosure rates increased in Wisconsin by more than 21 percent in the first quarter. What do you make of that, Clare?
Zempel: "Well, I think there will be lots of problems with people who stretched to buy homes, certainly since the middle of 2005, because those are the people who paid the highest prices and quite likely had to undertake the most debt. The problem in housing is one of prices. Housing affordability has declined. The big reason for the decline in housing affordability is prices rose so much. There has to be an adjustment. That adjustment will take the form of declines in some markets. It will take the form of several years, perhaps, of no changes in prices, until those prices are corrected or digested."
SBT: Real estate is always local, they say. The Midwest tends not to have the big mood swings that the coasts or some other markets have.
Zempel: "Yes, it didn’t go up as high and therefore probably doesn’t have to come down as much. But at the broad level, the national level, we have seen things similar to this as recently as the 1990s, before incomes caught up with where prices were. But those people who bought the homes last, the fellow who bought the home thinking he was going to flip it, and in fact needed to flip it, those people will be the people on CNBC and elsewhere screaming, but most people won’t."
SBT: I listened the other day to the conference call for Actuant Corp., a Glendale manufacturing company. They were talking about having to absorb an immediate skyrocketing of copper prices. Manufacturers here in Wisconsin are taking a double hit on raw material costs and energy costs. They’re having to decide whether to absorb those costs, but they increasingly are beginning to pass them along. With China and India increasing the demands for those things, do you see that continuing?
Zempel: "It’s quite clear you had speculators entering those markets, people making financial bets that prices will continue to rise. You had hedge funds and pension funds start to move into those markets. And those markets are thin. A hundred million dollars can move those markets quite significantly.
"That’s one of the things (Federal Reserve Chairman Ben) Bernancke has made a major point of …"
SBT: He’s always been a hawk about inflation, hasn’t he?
Zempel: "Right. And about deflation, too. It’s a problem. I think that’s in the process of being changed. I think that speculative interest is being chastised. I think commodity prices will probably come down some more and stabilize."
SBT: Really?
Zempel: "What we’re correcting is that speculative investment interests. In late 2004, early 2005, people were looking at their stock portfolios and their bond portfolios, and saying, ‘Oh, look at what’s happening in commodities. Maybe we should get some of that.’ I think the speculative interest is being taken out, which the Fed wants to have happen."
SBT: Bernancke is likely to continue to keep raising interest rates. Is that a good thing for the economy?
Zempel: "I think it is. The speech he gave (on June 5) … To me, he didn’t say anything new. He didn’t say anything he shouldn’t say. He certainly got the market’s attention. I think all he was saying was that after several years of economic growth, with the unemployment rate falling, because there’s less slack, he can say that he’s going to be more vigilant about inflation. He should be saying that. He should be saying, ‘We’re not happy that core inflation is 2.1 percent.’"
SBT: So, he seems to know what he’s doing?
Zempel: "He seems to know what he’s doing. And likewise, does it really matter whether the Fed goes up 25 basis points? Does that matter? Sure it matters. But will it break the economy’s back? No, it shouldn’t."
SBT: So, looking ahead at this "cool down," what will we see in the second half of 2006?
Zempel: "We’re going to see more of a slowdown in housing starts. We’re going to see increased competition among sellers of big-ticket durables items. That’s already resurfaced in the automobile industry, and that will probably continue, because what we’re talking about is a decline in the level of housing activity, and we’re talking about a decline, but not a collapse, in the growth of consumer spending. Pretty broad, general stuff, but that’s how I would paint the picture of the future."
