... And the hill becomes a mountain!

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The title of last year's Tennessee Valley outlook article was "The Bump in the Road Becomes a Hill." For 2008, that hill has become a mountain. The overwhelming influence on the Valley's economy for 2008 will be the national economy, and the national economy quickly deteriorated as 2007 came to an end.

At the beginning of 2007, national economic problems seemed fairly well contained within the housing and auto and related industries. Even oil prices, although remaining high, dropped in the first few months of the year from the peaks reached in 2006. The economic situation seemed on track for 2007 growth to be only moderately below potential before returning to trend growth in 2008--a path much like that of 1995-1996 when the Federal Reserve's (Fed) monetary policy slowed the economy, a breather that allowed the economic expansion to continue until 2001.

This relatively rosy scenario came to an end over the summer of 2007 as the problems with subprime mortgages spilled over into financial markets, with uncertainty as to size of losses and affected assets and with accompanying credit restrictions imposing restraints on economic growth. Consumers already stressed by the housing woes were hit with stock market losses and further credit limitations. Added to these problems were oil prices rising to $100/barrel and food prices quickly rising as well, cutting into income available for other uses. The end result was a dismal Christmas shopping season. With both manufacturing and private-sector employment also contracting in December, both of which had been holding up relatively well until then, the year ended on a recessionary note.

As a response to the gravity of the situation in the latter part of 2007, the Fed, which had been holding rates steady, changed policy to quickly try to provide liquidity and accommodate growth. Besides lowering rates since August, the Fed has started a "term auction facility," or TAF, to help the interbank lending market. The Bush Administration and Congress have also been discussing an economic stimulus package. Strong government action will help keep the economy from deeper contraction.

Additionally, one month does not a recession make, and it's questionable whether or not the December trend will continue. The national economy is not without its positive points. Low levels of initial unemployment claims at the beginning of January signal something of a rebound in employment. Exports continue to be strong with a lowering dollar exchange rate and relatively solid foreign economic growth, particularly in Asia. This has benefited manufacturers, although not enough to make up for slow domestic sales.

More importantly, part of the reason for lower production has been the reduction of inventories as sales wane, keeping inventories-to-sales ratios relatively low. This impedes growth now but sets up a situation where manufacturers will not need to radically curtail production later on. National consensus forecasts still call for only a very slow growth rate of around 2 percent for Gross Domestic Product (GDP) for 2008 as a whole, but with fairly flat growth in the first part of the year and about a 50 percent chance of an outright recession.

The Valley Will Follow the Nation

The Tennessee Valley's economy will generally follow that of the nation. Thus, growth of about 2 percent for the region's GDP is expected. Of course, if the nation sinks into recession, the region will as well. However, unlike during the recession of 2001, the region should not suffer disproportionately whether the economy is in a state of slow growth or recession.

The 2001 recession was considered mild for the nation. It was anything but for the Valley. Manufacturing was hard hit, and this greatly affected the region. Although the Valley's economy has diversified over the years, with developments in such industries as health services in Nashville and distributive services such as FedEx in Memphis, manufacturing is still the main driving force of the regional economy. This is especially true of the auto industry which has become predominant to the region's growth. (About 17 percent of the region's nonfarm payroll employment is in manufacturing versus 11 percent for the nation.) The Valley economy went into recession in mid-2000, earlier and deeper than did the U.S. By 2003, the Valley had lost 127,000 jobs in manufacturing, or 15.0 percent of its year 2000 manufacturing workforce.

In contrast, although manufacturing has been affected this time as well, it has been the economies that had grown strongly due to the earlier housing boom that have turned sharply for the worse over the past year, as both sales and prices have declined on a year-to-year basis.. In particular, the states of California, Florida, and Nevada have seen sharp decelerations. This was not the case in either the nation's heartland or the Tennessee Valley.

In general, the Valley did not see huge run-ups, and although currently seeing declines like the rest of the nation, the declines are moderate. Even the Nashville area, which saw the most growth in the region, was not among the upper tier markets during the boom, but the city continues to rank among the healthier housing markets in the nation. At last report, the areas housing prices were holding up even though sales numbers were lower and number of days on the market was longer. All areas of the Valley are seeing delinquency rates on first mortgages that are below the national average. The Nashville and Huntsville rates, especially, are much lower.

This does not mean that the Valley is exempt from the national conditions, just that it is not being disproportionately affected this time. Indeed, the region's growth relative to that of the nation has slowed since the faster-than-national GDP growth that occurred with the improvement in manufacturing after the 2001 recession peaked in 2004.

The Valley's economic growth in 2007 went fairly much as forecast in last year's article, with GDP growth slowing to the 2.25 percent-2.5 percent range, close to the national growth rate. With the region's high concentration of housing-related manufacturing industries, it was affected in late 2006-early 2007 by the national housing downturn as orders for homebuilding supplies such as lumber, vinyl siding, and roofing materials declined. The carpet industries in north Georgia had been cutting back on employment because of dwindling orders.

The contraction was not limited to direct suppliers to builders. Furniture and appliance manufacturers also experienced declines. These industries were already under pressure from foreign producers, and this further eroded their position.

In the middle of the year, manufacturing improved, helped by strong export orders. Metals, chemicals, and aerospace all did relatively well. With business investment holding up, capital equipment machinery also added to growth, especially given the prominence of Canadian, Japanese, and European competitors, all with currency values increasing versus the dollar.

Since then, the nation's low sales growth and slowing business investment have put a damper on manufacturing growth as inventories are being adjusted to the lower levels of demand growth. This has affected a broad spectrum of manufacturers, such as boat manufacturers in the Knoxville area, as higher income groups have started feeling the pinch. With the national housing situation not expected to see improvement until 2009 and U.S. demand remaining sluggish, these trends are expected to continue through 2008.

Autos and the Valley

In addition to the problem states mentioned above, the other state that is suffering recessionary conditions is Michigan. There the problems of the domestic auto industry have been the primary culprit, although housing problems have also been adding to the recessionary conditions. The main problem in the auto industry has been that there is too much supply for the demand, as domestic auto makers have tried to maintain market share to cover their large fixed costs. Domestic manufacturers particularly had already been hit by higher interest rates that reduced financing opportunities that were used as incentives. Credit problems have further exacerbated the situation. Also, high gasoline prices have reduced demand for what had been the most popular segment of the domestic manufacturers' market--gas-guzzling SUVs. At the same time, the foreign nameplate "transplants" have done relatively better with more popular models.

The Valley is in a much better position due to its higher dependence on the transplants. This is of particular importance to the regional economy since the auto industry has become predominant to the region's growth. The region has been at the center of the transplant movement where foreign nameplate auto makers have been opening plants in the U.S., and there has been a lot of auto-related investment in and around the region. The Valley has many auto parts suppliers, many of these supplying transplants that have either expanded or built new assembly operations in close proximity to the Valley, especially in Alabama. Honda built a new assembly plant in Lincoln, Alabama, and has already expanded it. Mercedes-Benz doubled its capacity at its plant in Tuscaloosa. Hyundai opened its first U.S. assembly plant near Montgomery, with its sister, Kia, opening its first U.S. assembly plant in Georgia near the Hyundai plant.