Vital signs: stable. Prognosis: Patient is out of immediate danger but condition is still fragile and requires constant observation.

That, in short, pretty much sums up the state of the American economy, the world’s largest. After a financial crisis that ripped apart the heart of its financial system in late 2008, the American economy is slowly showing signs of consciousness, aided greatly by emergency procedures initiated by the government and monetary authorities.

A year on, the US economy is forecast to have grown at its fastest pace in about four years in the December quarter. A Bloomberg survey of economists indicates GDP is expected to expand by 4.6 per cent, more than twice the rate of the previous quarter. Because the worst of the financial crisis unfolded between the last quarter of 2008 and early 2009, GDP numbers for the first half 2010 are expected to look pretty robust because of the ‘low base’ effect. Yet there are other signs of improvement. Companies are starting to report improving revenue numbers, indicating a slight pickup in demand. Factory orders have climbed, helped mainly by depleting inventories. Orders for durable goods are predicted to have risen by 2 per cent in December, according to the Bloomberg survey. US productivity also gained all through 2009, rising by 2.5 per cent (in per hour terms), according The Conference Board as output declines were largely offset by dramatically lower working hours (employment fell by 3.6 per cent in 2009, while hours worked per worker slipped by 1.5 per cent). This year, productivity is projected to rise by 3 per cent. More importantly, US consumer confidence in January hit its highest level in nearly a year and a half. The Conference Board’s index of consumer attitudes rose to 55.9 in January, the highest level since September 2008 and up from 53.6 in December.

High confidence

US consumer confi dence in January hit its highest level since September 2008

Source: Bloomberg

That’s the best sign of optimism yet, because consumer spending is at the heart of this patient’s recovery. Consumer spending accounts for 70 per cent of the economy and any improvement in confidence bodes well. The big question is, how sustainable can this confidence be when the jobless rate is still at 10 per cent? Companies may be buying more equipment, but they’re not hiring much. Nursing losses from sunken house prices and equity markets, consumers are still not going to be able to go out and spend with abandon. “Consumers are still hunkering down and rebuilding their balance sheets and saving,” says Kevin Grice, senior international economist at Capital Economics, a research organisation in the UK. “Unless we see a sustainable improvement in the jobless rate, consumers are going to remain unwilling to spend.” He estimates the economy needs to create at least “150,000 jobs each month to get consumption rising again”. For now, that seems extremely unlikely. In the fourth quarter of 2009, job(non-farm) losses in the US averaged 69,000 per month. “While the US economy is recovering, it will be a jobless recovery and it will be a long time before we see a fall in the unemployment rate,” he adds.

One of the best gauges of consumer spending, retail sales, fell by 2.5 per cent in 2009, according to industry body National Retail Federation. This year, sales are predicted to climb by 2.5 per cent on the presumption that jobs and home prices will stabilise. That’s a big if, given that home prices were unexpectedly down 0.2 per cent in November from the earlier month, according to the Case-Shiller home price index released by Standard and Poor’s.

To encourage consumers and businesses to spend, the government unleashed a massive fiscal stimulus package that included schemes such as cash for clunkers, to spur Americans to buy more fuel-efficient cars using cash they received by trading in their old models. But that kind of spending support is expected to largely run out of steam by the middle of this year, and there are fears about how the economy will hold up if it is taken off the life support of government spending. Those fears will most likely hold back the Federal Reserve from raising interest rates even modestly for most of the year. The current bet among economists is that the target rate for overnight lending among banks will stay in the 0-0.25 per cent range for most of 2009, with a small chance that it could be raised by 50 basis points in the last few months of the year.

For banks, that will make little difference because even with record low rates, they aren’t lending and debt-burdened consumers aren’t borrowing. The Federal Reserve has released trillions of dollars into the financial system but very little of that has reached borrowers because most banks, nursing big losses from the sub-prime mortgage mess, are rebuilding capital and preferring to park their funds in money market instruments rather than take on the risk of lending and additional consumer defaults. With good reason. “Banks continue to face problems in two areas -- consumer credit and commercial real estate,” points out Grice. “Both are problem areas in which the troubles have not yet peaked, although we believe the two areas combined do not represent as big a problem as the sub-prime mortgage crisis.” It will still weigh on bank earnings. JP Morgan and Bank of America, two of the bigger banks in the US, recently warned of continuing losses on consumer credit.

US President Barack Obama’s proposals to prohibit commercial banks from making trades for their own accounts and prohibiting banks from owning or investing in hedge funds or equity funds isn’t helping matters any. On January 21, the day he announced the proposals for sweeping changes, the S&P 500 tumbled by 2 per cent, taking the overall drop to 4 per cent since.

All in all, this may not be the year that US shoppers come back to the stores in force, although the economy will continue to report improving numbers on other fronts. That will most likely mean choppy growth for the US, with economic output expanding strongly in the first half but faltering in the second. Of course, this assumes nothing terrible happens in the meantime.

It looks like this patient is set for a long stay in the recovery ward.