Why this will not be a normal cyclical recovery
This weekend, the Financial Times had a great piece written by Roger Altman, the former United States Deputy Treasury Secretary under Bill Clinton. The piece, titled Why this will not be a normal cyclical recovery, jibes with my thinking on the current recession.
I don't know if I am going to be right, I have been thinking and reading a lot about this mess and I have been fairly consistent in my message that I don't believe that this is the end of the world, but that this is going to be one very, very long economic slowdown. Consumers and the U.S. government have way too much debt and the demographic trends of the aging U.S. population are so negative that I don't see any other possible explanation for what is going to happen.
All of the debt that consumers and the government have will not just magically disappear. Consumers are going to have to save more and spend less to get their balance sheets in order. This is even more important today after the massive wealth destruction that we have seen over the past two years.
The Baby Boomers who haven't retired already are rapidly approaching retirement. They are going to need to save, save, save. Even middle aged and young people are going to feel less secure about their financial future and want to save more as pensions and annuities that are based upon overly optimistic assumptions on the rates of return that they would generate blow up and the future of Social Security comes into doubt. Does anyone really believe that Social Security will exist when they retire? As someone in my late 30s, I'm certainly not counting on it. I'm working hard today so that this absurd Social Security ponzi scheme can cut my Mom and Dad checks. It's not some sort of real savings account, it's a joke and nothing more than another hidden tax.
Any recovery in the near term that is generated by stimulus packages, etc... will likely be short-lived. Eventually someone is going to have to pay off all of this government debt. The budget deficit is going to be much worse than the Obama administration is projecting with its overly optimistic assumptions about economic growth. Today's massive spending will eventually rrear its ugly head in the form of higher taxes or a lower U.S. dollar, or both. There's no such thing as a free lunch in this world.
I don't think that we're all screwed, just that there won't be any growth. That's why I am investing for yield in preferred stock and bonds, as well as some relatively secure dividend paying common stock.
Anyhow, enough ranting. Here's what Altman has to say on the subject:
The rare nature of this recession precludes a cyclically normal US recovery. Instead, we are consigned to a slow, painful climb-out, as are nations such as Japan and Mexico that depend on US demand...
What is unusual is that this is a balance-sheet driven recession, centred on the damaged financial condition of both households and banks. These weaknesses mandate sub-normal levels of consumer spending and overall lending for about three years.
In contrast, most postwar recessions had a different sequence – rising inflationary pressures, a monetary tightening to counter them and, then, a slowdown in response to higher interest rates. This was the pattern of the sharp 1980-81 slowdown.
None of that happened here. Instead, we saw a housing and credit market collapse that caused enormous losses among households and banks. The result was a steep drop in discretionary consumer spending and a halt to lending. To see why recovery will be slow, we can look at the balance sheet damage. For households, net worth peaked in mid-2007 at $64,400bn (€47,750, £43,449bn) but fell to $51,500bn at the end of 2008, a swift 20 per cent fall. With average family income at $50,000, and falling in real terms since 2000, a 20 per cent drop in net worth is big – especially when household debt reached 130 per cent of income in 2008.
This debt derived from Americans spending more than their income, reflecting the positive wealth effect. Households felt wealthier, despite pressure on incomes, because home and financial asset values were rising. Now that wealth effect has reversed with a vengeance. The crisis and unemployment have frightened households into raising savings rates for the first time in years. They had been stagnant at 1-2 per cent of income but have surged to nearly 5 per cent. With reduced incomes, only cutting discretionary spending can produce higher savings. This explains why personal consumption expenditures fell at record rates at the end of 2008.
Consumer spending, however, has approximated 70 per cent of US gross domestic product for the past decade and dominates our economy. But household balance sheets will not be rebuilt soon. Home values will keep falling through mid-2010 and there is no precedent for equity markets, still down 45 per cent from their peak, to make those losses up in just two years. It is illogical, therefore, to expect a full snap-back in the consumer sector in 2010 or 2011. This alone mandates a drawn-out, weak recovery...
A third constraint on recovery may involve the federal balance sheet. The fiscal and monetary engines are currently on full throttle. But, within two years, concerns over budget deficits and inflation may revive, compelling the Federal Reserve to raise interest rates and Congress to adopt deficit reduction steps. These actions, contractionary by definition, could occur before a full recovery has asserted itself. On that basis, the federal balance sheet would also limit a full recovery.