Fundamental question: Is economy really OK?

updated 2:22 p.m. ET Sept. 17, 2008

WASHINGTON - Unemployment is at a five-year high. Financial firms that withstood the Great Depression are failing. Congress and a lame-duck president are gridlocked. So when John McCain declared that "the fundamentals of our economy are strong," it drew ridicule from Democrat Barack Obama.

McCain later toned down his remarks, but his observation reflected a debate among analysts and policymakers about the economy's underlying health. Plenty of them think he's right.

Polls show a majority of voters put the economy as their No. 1 concern with seven weeks to go until the presidential election. Many economists believe we are now in a recession. Signs of economic distress are everywhere as housing prices continue to fall and the nation's financial system is pounded by a series of shocks, including the Federal Reserve's stunning $85 billion takeover of insurance giant AIG Tuesday evening.

"Strains in financial markets have increased significantly and labor markets have weakened further," the Fed said in a sober assessment Tuesday. But in deciding against lowering interest rates, the central bank signaled that it didn't see the economy's present situation as dire.

"When you have jobs being lost, industrial production down, personal incomes down and so forth, the economy's not in good shape," said Nariman Behravesh, chief economist at Global Insight, a Lexington, Mass., forecasting firm.

Still, he added, "If the issue is whether the U.S. had a dynamic, resilient economy, and that the long-term trends are positive, I completely agree. ... It's important not to get carried away with gloom and doom."

And David Wyss, chief economist for Standard & Poor's, said that while there is a serious financial-sector problem "the fundamental economy actually isn't in that bad a shape." But, Wyss added, "I still think we're in a recession."

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That dichotomy is at the heart of the dispute over McCain's remarks.

McCain declared on Monday that "the fundamentals of our economy are strong," a phrase he has used before. After Democrats pounced, he backtracked and declared the economy to be in a crisis and said "fundamentals are threatened."

Democrats kept up their assault. "How can John McCain fix our economy if he doesn't understand it's broken?" asked an Obama TV ad.

The housing sector is in near meltdown, with new-home construction at a 17-year low, according to a government report issued Wednesday.

The financial sector is in turmoil not seen for at least a generation, with Morgan Stanley, one of only two remaining big U.S. investment banks, reportedly considering a potential merger with a larger commercial bank. Washington Mutual, a giant Seattle-based banking company, appears to be teetering, with the Federal Reserve looking to help broker a sale.

Yet the larger economy is plodding along, the numbers suggest.

After turning negative in the final three months of 2007 and growing at an anemic 0.9 percent in the first three months of 2008, the nation's gross domestic product — helped by government stimulus checks — grew at 3.3 percent in the April-June quarter. A relatively weak dollar has helped U.S. exports. High prices for food and other commodities have helped agriculture and the energy and mining industries.

A survey of CEOs by accounting firm PriceWaterHouseCoopers found that while the unemployment rate jumped to 6.1 percent in August, a majority of the top corporate leaders surveyed said they are not planning significant cutbacks of people, products or services. Instead, the CEOs are focusing on opportunities to improve efficiency and ways to emerge from the slowdown in a better position to compete.

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