Many commentators - and stock market traders - were heartened by comments of White House and Fed officials who saw some "green shoots of spring" in the US economy. The speed of the recession is decelerating, they say. The notion, never accurate, that the economy was in "free fall" has been discarded.
None of that should be surprising. Government officials are paid to accentuate the positive. Moreover, published White House and Fed economic forecasts have consistently predicted the economy would bottom out later this year. And forecasts of most private sector economists run along the same lines. Even I think the recession will end this fall.
Where opinions differ, however, is what happens next. Will the business recovery be solid and self-sustaining? Or will it be fragile and vulnerable to a renewed set back? No consensus has jelled on the outlook for 2010 and beyond.
Washington is clearly in the optimistic camp. The White House budget is based on an assumption of 3.2% growth in real GDP for calendar year 2010. The non-partisan Congressional Budget Office predicts 2.9% growth. The Federal Reserve's latest published forecasts for 2010 show a wide dispersion among Fed officials but most are clustered in that same range.
Their optimism is based on three factors. They assume history will repeat. Deep recessions have always been followed by strong upswings, they say. They take for granted that the combination of aggressive monetary policy and powerful fiscal stimulus will generate strong increases in business activity. And they assume the financial markets will get back to normal soon.
My forecast is much less cheerful, a 2010 rate of GDP growth of only around 1 ½%. Fundamentally, I doubt that history will repeat, because this recession is unique. It has been caused by massive wealth destruction, not simply the normal forces of the business cycle. It is the culmination of many years of excesses in the credit markets that have literally brought the financial sector to brink of collapse. Americans indulged on cheap and easily available credit to spend much more on cars and houses than they could afford. They were betting that prices would keep rising, especially home prices, and that would bail them out. As evidenced by rising mortgage defaults and foreclosures, they have learned a painful lesson.
Now US households are confronted with a number of cruel realities. Their jobs are at risk because of severe dislocations in US industry. Whole industries are threatened by bankruptcy, notably motor vehicles. Wages and salaries are under tight control everywhere, as businesses struggle to lower costs. New hiring is severely restricted even in industries that are still reasonably healthy. Moreover, state and local tax revenues are down so sharply that school boards are unable pay teachers already on their payrolls, normally the most stable occupation in the economy.
But worst of all is what has happened to household wealth. It has plummeted because of falling home prices and the sharpest drop in equity prices since the 1930s. Back then, however, only a slim fraction of Americans owned stocks, essentially the wealthy. Nowadays, things are completely different. The majority of middle-class Americans depends on self-directed pensions, the familiar 401k accounts, to provide for their retirement, over and above the limited benefits received from Social Security. Those 401k accounts are now down 30%-40% from their peaks.
Consequently, the US consumer is in no position to become a dynamic force for economic recovery. If anything, millions will seek to increase savings to replace part of this lost wealth. They will not rush out to buy new homes, because they rightly fear further erosion in housing values. They will be content to keep their cars a little longer, rather than buy new ones. Even if some consumers are inclined to increase their spending, they will face continued credit restraint imposed by hobbled banks that have established far more restrictive lending standards.
This so-called negative wealth effect will influence business decisions, too. Firms will be more selective in approving capital expenditures and will retain tough control over costs. They will also face difficulty getting credit, particularly for commercial real estate development.
Finally, the global nature of the current recession is unprecedented. US exports have already been adversely affected, and foreign demand will remain suppressed for some time.
To me, it adds up to a weak recovery, at best. I suspect that the Fed's easy money policy will continue and that the Obama administration will prepare another fiscal stimulus package. These supportive policies are essential to avoid a "double dip" recession. But they will be insufficient to generate the traditional robust recovery that White House and Fed economists apparently believe will be underway a year from now.
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