Are We Headed for Recession?

Nov. 8, 2007— -- Watching the stock market these days can give you whiplash.

Every day seems to bring more jitters on Wall Street. Stocks plunge 360 points in hours, another financial powerhouse tells investors that it is going to take bigger losses than expected, CEOs lose their jobs and more Americans can't keep up with their mortgages.

To top all of that off, oil keeps hitting record highs, the dollar is plunging and retailers are moving sales earlier in the year, hoping to jump-start the holiday spending season.

So is our economy in shambles?

Federal Reserve Chairman Ben S. Bernanke came to Capitol Hill this morning to try to answer that question.

His message: The overall economy has performed well since March but will slow in the coming months because of rising energy costs and weakness in the housing, financial and credit markets. Bernanke said that he expects the housing market to hit bottom in the coming months, with the economy starting its recovery in the spring.

Bernanke said the Federal Reserve sees growth "as remaining sluggish during the first part of next year, then strengthening as the effects of tighter credit and the housing correction began to wane."

Bernanke went as far as to say that today's problems will ultimately help the economy.

"The recent developments may well lead to a healthier financial system in the medium to long term," Bernanke told the Joint Economic Committee. "Increased investor scrutiny of structured credit products is likely to lead ultimately to greater transparency in these products and to better differentiation among assets of varying quality."

Sen. Charles Schumer, D-N.Y., chairman of the Joint Economic Committee, asked the question on many minds: "Is a recession out of the question?"

Bernanke wouldn't make a prediction, saying "economists are extremely bad at calculating turning points." But he said that by the spring he expects that the "housing market begins to find a bottom."

As the housing market stops its fall, Bernanke said, the other, growing parts of our economy would lift the overall economy in the long-term.

The Fed chairman did not give any indication that the central bank had plans at this point to further cut interest rates. That news drove the market down by midday.

The Energy Crunch

This week has seen oil climb to a new intraday high of $98.10 a barrel, with many analysts saying that $100 a barrel -- a once unimaginable thought -- is on the horizon. It's no longer a question of if it will hit $100, but when.

Oil has been driven up in recent days by fears of political instability in the Middle East, a pipeline bombing the other day in Yemen, a storm shutting down North Sea oil platforms, production issues in Mexico and a fire at a Texas refinery. None of these factors alone drive up the price of oil, but they make traders jittery about the availability of next month's crude.

Further compounding this is the falling value of the dollar. Oil is traded in dollars, and when the dollar falls, oil generally rises.

This has ramifications for all segments of the economy.

Most Americans are already seeing the impact through higher gas prices. In past years, gas prices have declined coming off the peak summer driving season.

That never happened this year and in the last few weeks, gasoline prices have started to tick up rising 14 cents in the last week alone. The average cost of gas across the country now stands at $3.01 a gallon with motorists in California paying $3.23 a gallon, on average.

The rising prices will also hurt Americans who have to heat their homes this winter.

The Energy Information Administration this week predicted that the average household would see their heating bill rise $97 or 11 percent over last year. Only a month ago, the government agency had only predicted an $88 or 10 percent climb.

Those hit hardest this winter will be residents of the Northeast, who primarily use heating oil. People who use propane will be hit hard too, followed by those who use natural gas and then electricity, primarily those in the South.

The airlines, which have only recently returned to profitability, could be dramatically hit by spiking oil prices.

United Airlines on Thursday become the second airline in a week to announce that they will raise ticket prices to help offset the rising cost of jet fuel. American Airlines announced a similar hike last week.

United also yesterday said it could ground up to 100 or more of its airplanes if soaring fuel prices ultimately cause consumers to buy fewer tickets.

The increase in oil prices will also affect the cost of transporting the millions of everyday products from their factories to our local stores, as well as the cost to move the raw materials to make those products.

The Good News

Bernanke said that while there are weaknesses in parts of the economy, the overall labor market is strong, as is the country's export level..

Last week, the government released the latest data on the overall economy, as measured by the Gross Domestic Product. The report showed that things were doing a bit better than expected during the July to September time period, with the GDP increasing at a pace of 3.9 percent -- the highest quarterly growth rate in a year and a half.

Two main factors drove up the GDP. First Americans continued to shop. Second, exports grew at the fastest pace since the last part of 1996. American exports are flourishing because the dollar is so weak -- everything we make is effectively on sale to the rest of the world.

Schumer questioned Bernanke if declining house prices would affect this growth in spending.

Bernanke said, yes but with a big caveat.

"Certainly as consumers see their home values decline, it will affect their long-term thinking toward spending," he said, noting that decline would probably be offset by a generally strong labor market.

And what about reports yesterday that China might start shifting its investments away from the U.S. dollar?

"I don't see any significant change in broad holdings of dollars around the world," Bernanke told the committee. He said the dollar will be strong "in the medium term" and that he expects it to continue as a standard around the world because of the overall strength and security of the U.S. financial markets.