What Will Economic Recovery Look Like?

Over the last few months we're had several important signs that the economy may be bottoming. The Conference Board has recently reported that leading indicators spiked up last month and consumer confidence has improved. In addition, the number of people who say the country is on the right track has been increasing since October, while the number of people who say the economy is getting better is increasing. We've possibly seen a bottom in retail sales and durable goods orders. Finally, it appears that the four-week moving average of initial jobless claims as topped out. While all of this is preliminary data which could change given the volatile nature of the economy, things do appear to be moving forward. That means we need to start looking at what kind of recovery we'll see. And in that category there is a great deal of concern about what will actually drive growth.

To illustrate this issue, let's break US GDP down into its four components. Personal consumption expenditures, gross private domestic investment, exports and government spending.

Personal consumption expenditures account for 70% of US economic growth. Unfortunately, the US consumer does not appear ready to lead the economy out of recession. The main issue is US households are heavily indebted:

U.S. household leverage, as measured by the ratio of debt to personal disposable income, increased modestly from 55% in 1960 to 65% by the mid-1980s. Then, over the next two decades, leverage proceeded to more than double, reaching an all-time high of 133% in 2007. That dramatic rise in debt was accompanied by a steady decline in the personal saving rate. The combination of higher debt and lower saving enabled personal consumption expenditures to grow faster than disposable income, providing a significant boost to U.S. economic growth over the period.

In the long-run, however, consumption cannot grow faster than income because there is an upper limit to how much debt households can service, based on their incomes. For many U.S. households, current debt levels appear too high, as evidenced by the sharp rise in delinquencies and foreclosures in recent years. To achieve a sustainable level of debt relative to income, households may need to undergo a prolonged period of deleveraging, whereby debt is reduced and saving is increased.

Here is the accompanying chart:

Simply put, US households have gone on a debt acquisition binge over the last 30 years. The primary event forcing them to deleverage is the massive loss of assets over the last few years thanks to the stock and housing market corrections. According to the Federal Reserve, household wealth has decreased from $64.361 trillion in 2Q07 to $51.476 trillion in 4Q08, or a decrease of 20%. This decrease means households have fewer assets relative to debt, meaning households are in fact poorer. This in turn forces consumers to pay down debt at the expense of spending. In summation, there is little reason to think that consumers will return in droves to the malls. It is far more likely they will consume less, leading to a slower recovery.

Next, there is investment. Here is a chart of the percentage change from the preceding quarter in gross private domestic investment.

Notice how this number has been negative for nine of the last 12 quarters. In other words, the US economy is already in an investment recession. And there is little reason to think we'll be coming out of it anytime soon.

Housing starts are already at 40 year lows.

Capacity utilization is also at 40 year lows, meaning there is little incentive for companies to buy new capital equipment.

Commercial real estate prices are falling as well, indicating a lack of demand and therefore no need to build more commercial property.

In short, there is no reason to think investment will bring us out of the recession either.'

Then we have exports. First, remember the US is is a net importer and has been for several decades. That means exports haven't bee a positive contributor to GDP for some time. But most of out trading partners are also in a recession so they have no need to buy things from the US. In other words, don't expect exports to bring us out of the recession either.

Simply put, there are no parts of the economy ready to step up to the plate and take the lead pulling the US out of recession. As a result:

Americans may have to get used to unemployment greater than 8 percent for the first time since 1983 and an economy that won't grow much beyond 2 percent as a consequence of the lost confidence in consumer credit that shattered financial markets.

By this time next year, "the market will realize that potential growth for the U.S. is no longer 3 percent, but is 2 percent or under," Mohamed El-Erian, chief executive officer of Pacific Investment Management Co., said in an interview with Bloomberg Radio.

Comments

[denny8844]

Dont expect things to be better for several years learn to eat corn flakes for dinner and go without bottled water and not see a movie for 5 years and not going out to a restaurant until you are 12 and drive one car and no vacations and making a choice between buying pack of cigarettes and quart of milk for the kids Ohhh gee sounds like the 1950's But then being poor wasnt so bad cause we didnt know we were poor since everyone else was in the same boat

[paixa3]

You are going to have a recovery? I do not think so.

The rest of the WORLD already own you.

[Waubay]

With his monicker 'Bonddad' I would think that he was cognizant of what is happening in the bond market. Anyone that is cognizant of what is happening in the bond market would not be predicting a bottom any time soon. They would be predicting another severe downturn. The bond traders are going to push and see how far the Fed will go to keep rates down. How long will foreign central banks keep throwing their money away buying T-Bills knowing that not only could they get a better rate later but that the US Government could be at the point where it is impossible to pay off all this debt? Our government desperately needs to sell T-bills at low rates, and lots of them, or the government will have no money to function. We saw the shot across the bow last week that spiked 30-year T-bills and sent mortgages up over 1/2% within hours. If we have a bond market dislocation we could see rates double. The housing market has to stabilize before any recovery can begin. Where will house prices have to be if the interest on a 30-year mortgage is 8-9%. How about all those Alt-A and Option-Arm mortgages readjusting to 9-10%. Don't pay attention to the stock market - it is being completely gamed. Watch 10-year and 30-year T-Bills. That is where you will see the beginning of the next crash.

[yappnmutt]

the bond guys are the smartest guys in the room. but if they are selling usa treasuries where are they putting their money? i think they are buying yuan currency swaps and commodities. the bet is on china.

[invisihand]

I like your articles, Bonddad. They always have good stats and analysis, although I want to point out a few things:

"The main issue is US households are heavily indebted"

True. This problem is compounded by the shrinking job market, and shrinking wages. We are down to one income in my household (mine, wife was severed in Dec 2008, still unemployed) and we're fortunate to be in pretty good shape in the debt dept, but we are cutting costs as much as possible. That's the thing that really bugs me - we are supposed to feel good that job losses are slowing but with no mention of job growth. This is a very bad sign.

All of the "experts" point to employment stats as a lagging indicator. That may be true, but it is huge indicator none the less. A "jobless recovery" will not cut it.

[Paul]

What about hyperinflation?

With so many people owing so much, and the government spending stimulus money like water, perhaps we will all be able to pay off our mortgages with a weeks wages in 2015...

Maybe inflation will become the politically acceptable solution:

1. Everyone gets out of debt by paying up in devalued dollars.
2. China revalues its currency and it makes sense to manufacture things in America again.
3. Gasoline prices go sky-high and we stop importing automobiles
4. We remake our economy based on mass transit, small-scale manufacturing and no debt.

Not so good for those of us who are trying to save for retirement, however.

[Waubay]

Only problem is that wages are not increasing. Wages have been almost stagnant for over 10 years.

[RandVictims]

Why should Capitalism be saved? What good comes out of this system?

[Indra]

Yes, that looks like the scenario however I would suggest that we are entering a mini depression. Jobs lost that will not be recovered, loss of credit transactions that have allowed our consumer society to flourish but eventually die, lack of a manufacturing base and any industry that could take its place that is not already in full swing in other countries. This spells DOOM! Basically someone has to come up with the magic answer and well guess what; there is none. Protectionism will be the order of the day as well as conservation of resources IE: no more trees logged in the US to make throwaway Japanese chopsticks. Anyone who says that we have to do global economy the way it has recently been set up is not understanding the world and its ways. They will very soon however.

[beaupritchard]

What gets me is companies are able to patent products and processes. They then are protected from other competitors not having the research and development over head and just producing already made products.

When it comes to the development of a three or four generational process like steel or automotive no patents are let to the workers to protect them from foreign competitors taking that generational intellectual property and producing products for the american market.

Government is suppose to provide that protection through tariffs.

So what happened .... Economist were able to convince politicians that a policy change(spe­cializatio­n and free trade) could boost productivity without including the disruptive cost it would have on the society they wished to change.

America was sold out. Whole generations of workers were lost and with their lost we became the biggest debtor nation on the planet.

Even now the right answer protecting the intellectual property of generations of workers is kept off the table. Were tariffs imposed and "fair" trade inforced no american would be out of work.

[ClarcKing]

Omissions make this a terrible article. I don't why you did not come to the conclusion that unemployment in the millions is a serious problem that must be arrested now or the present collapse will worsen making recovery impossible. The bailouts are not working in their design and/or intention. The monetary financial derivative debt based global economic collapse is accelerating the contraction of the economy and population: demanding speculation, usury, perpetual war, forced trade, out sourcing industry and jobs, unemployment in the millions, cost cutting in medical services, medicine education and food production. Meat producers are under severe market pressure to close their operations. Put the Fed into bankruptcy, create the U.S. National Bank. Credits and currency will be issued into the population's physical economy. Jobs and purchasing power will be introduced into the economy. Expand Social Security and Medicaid. Stop the foreclosures. Enact the Homeowners and Bank Protection Act. Food, water and energy harvesting, production and distribution must be maintained at present levels and increased wherever possible. Start the construction of 100 Nuclear energy generation and distribution systems. You must see this as a National Security crisis. Financial warfare is being conducted against the United States and its' population via control of the national perspective.

[yappnmutt]

run a chart of household debt with a chart of the growth in gdp to measure the growth in gdp as a function of debt. then realize the equilibrium of household debt to income and you will see why .gov wants to inflate its way out of this mess. of course , .gov has missed the point. the only real fix to the present economy is an increase in incomes which lags inflation. we are doomed because the economy will be crushed before incomes catch up.

[rugbymom]

One weakness of all these statistics is that they only measure what the government gets reporting on. I see a large, and probably growing, off-the-books economy -- sales of used goods on craigslist, book swaps, people helping each other out at community gardens, people working for cash and no one is reporting it to the tax authorities.

We're also measuring the wrong things -- case in point, "new housing starts." In my area, we are way overbuilt, losing population steadily for years, while adding hundreds of housing units. The era of empty second homes and large one-person dwellings was unsustainable and ecologically insane. We need weatherization, retrofitting, lead abatement, and affordable rents -- but not more units. People will have to go back to living with more people per household, to cover the expenses, and that is good for energy use, natural resource use, etc. Same with new car sales -- we don't need the number of new cars the automakers were pumping out. Give us some new data that measures different things -- how many children had to move during a school year; how many vegetable gardens; how many added bike racks; how many trees planted.

[humanbeing-rick]

What will economic recovery look like in America? I will tell you:
1) Massive rioting and violence through all major cities
2) Rape, rob, and pillage all the rich suburbs and ranches
3) Public hangings of the corrupt, rich and powerful traitors that got us here
4) Military forces join the people movement
5) Forcible re-distributuion of wealth by the people and for the people

It is just a matter of time now.....

[larry278]

You know,...ri­ck, your rosy predictions may become true.

[Databyter]

All your indicators are looking at people based models.

They don't take into consideration the stimulous without stimulation.

They don't take into consideration that this administration is spending so much so quickly that even the Russians and the Chinese are telling us that we need to go back towards Capitalism.

All this spending just delays the final bursting of the bubble that got us here, and it will make the final collapse much much worse.

It is undisputable that you cannot spend 6 Trillion dollars (that is 6 million millions) that you don't even HAVE by inventing money and borrowing money without having drastic effects.

We have virtually insured mega inflation like nothing this country has ever seen, to think that we are bottoming out NOW is ridiculous, This time next year we will not even be at the bottom, we will just be so much worse off that we will look back at NOW with fond memories.

Stop the spending, Save your children and grandchildren.

People who don't see that this man who you praise has repeatedly lied about just about everything are blind, how can you give healthcare to everyone in a recesion and not increase taxes, how can you say that legislation will be reviewed by all americans before it is voted on and then vote the biggest spending bill in history and the legislators werent even allowed to see it.

Wake up.

[RandVictims]

The Russians and the Chinese LOVED Reagan "Free Market" Capitalism because it made them superpowers on the backs of U.S. taxpayers while eroding the U.S. to the status of a 3rd world country.

Second, don't confuse "Market-based Communism" with Capitalism. Those in the government that destroyed the Middle Class and willfully gave our intellectual property and technology secrets to China committed treason out of greed and hate (the hate being that of the U.S. middle class)

There was nothing, - **absolutely nothing good*** about Ayn Rand Capitalism. It will always be remembered as an embarassing, and worse yet, catastrophic period in U.S. history.

[watchTVgetSTUPID]

During the month of August 90,000 people will run out of unemployment benefits in Michigan alone. This is the face of America's recovery ... all lies and all bad for you.

[olephart]

The recovery won’t be a recovery. Obama has made three fundamental mistakes, Summers, Geithner and Bernanke. He has allowed his policies to be focused on propping up those who caused the financial carnage. Every dollar that has gone to refill the coffers of the craven warlocks of Wall Street has been diverted from rebuilding the economy. Indeed the overt fraud that brought this Nation to its knees has been swept aside like so many other crimes of the preceding eight years. A strong and lasting recovery cannot be built on such a shoddy foundation.

Despite complete sentences with pretty words our Foreign Policies of War and Empire continue. These affronts to reason exist only to insure continued waste of blood and treasure in the name of security. This is the moral and financial albatross round our necks that keeps our heads down and shoulders stooped.

We are coddled and corrupted by our tax and social systems giving too much to too many for too little. From those paying themselves a King’s ransom to oversee fraud to those who expect support for the results of their procreation we reward misbehavior and punish virtue.

We selected leaders who betrayed us and we availed ourselves of the indebtedness they offered for crass comforts. We were oblivious to reality until it was thrust upon us and now we are nonplussed. Until we as a Nation demand and accept the truth we are destined to wander aimlessly in the wilderness of wanton denial.

[Indra]

Amen!

[HTooley]

Maybe we should call it the Sinai recovery. America wandering in the economic desert for a generation. Good post.