MAKING CENTS — How Slow Is Too Slow?
To say that the economic recovery has been uneven is to restate the obvious. Initially, growth came back strongly, boosted by inventory rebuilding and strengthening private sector activity. Last summer, however, the recovery started to weaken and has slowed down markedly this year. Temporary factors, such as spiking commodity prices and supply chain disruptions related to Japan’s natural disaster, held back economic activity earlier this year. But the slowdown cannot be explained by those factors alone. Over the past few quarters, the recovery has lost its momentum, and downside risks to growth have risen notably.
Consumer spending, which accounts for approximately 70 percent of total demand, grew very modestly in the first half of
this year. The higher cost of living and the weak labor market are the likely culprits that have discouraged consumers from increasing their expenditures significantly. Recent consumer spending numbers were a bit higher than expectations, but still not at a level that would make for a robust recovery. But, at least consumers are spending, and at a level that is higher than prerecession levels.
The Big Culprit
The depressed state of the housing market is probably the bigger culprit that continues to discourage consumption, particularly for big-ticket items. The stream of foreclosures is continuing to contribute to a high inventory of homes for sale and keeping downward pressure on home prices. This inventory must clear out before we will start seeing any major improvement in new housing starts.
Slow improvement in the labor market has been particularly disappointing. Job growth remains too low to bring down the unemployment rate, which remains slightly above 9 percent. People in all age groups continue to leave the labor force, and the employment-to-population ratio is now at its lowest level in more than 25 years.
Ironically, there are jobs in certain parts of the country, but qualified folks are straddled with mortgages to get there. The entitlement mentality that “everyone deserves to own his or her own home” has bitten us in the rear. At a time when we most need a work force that is mobile, they are anything but.
In response to the slew of weaker-than-anticipated data, most economic quant-jocks (forecasters) that I follow have revised down their long-run estimates of gross domestic product (GDP) projections for this coming year and the next. The silver lining however is that they are projecting growth and not the other way around.
A Glimmer of Hope
Although the overall picture has worsened, there remain pockets of strength in the economy. Business investment is growing, in part supported by low financing costs. Export growth also remains solid as economic expansion continues in our major trading partners. Employment in the energy sector has increased, providing a big boost to the local economy in energy-producing areas.
On a national level, the negative effects of the unusual forces that restrained the economy in the first half of this year have diminished. While financial risks have increased (mainly from Standard & Poor’s downgrading of U.S. treasuries), most economists (including myself) do not expect a recession relapse.
In my view, there is sufficient fundamental strength in the economy for a modest cyclical recovery to proceed while the process of necessary structural adjustments moves along. I personally believe the unemployment rate will come down very gradually over time, but there may be a new, higher level of what constitutes “normal” unemployment.
One of the major structural adjustments that is currently holding back the recovery is deleveraging. Deleveraging is the process ofreducing the debt burden of a household, a business, or a government. It has proved to be a potent force that has reduced the economy’s ability to heal more quickly after the last financial crisis and the ensuing recession.
Good Debt vs. Bad Debt
Debt is not, in and of itself, a bad thing. Debt supports economic growth by allowing households, businesses, and governments to smooth their spending and investment over time. Borrowing and lending helps facilitate the allocation of capital to productive uses in the economy. But high debt levels can also result in lower economic growth and this is indeed what we have witnessed.
Declining home values along with rising unemployment have set in motion a process of deleveraging by the household sector. Household deleveraging has occurred mostly through a combination of increased savings, debt repayment and also debt forgiveness.
At the same time, there has generally been less access to credit for households as a result of stricter underwriting standards. The inability to qualify for home equity loans and other forms of credit has slowed the pace at which households replacing paid-down debt take on new debt. The effect is to reduce their debt burden over time. From its peak in 2009, total household debt has declined to around 90 percent of GDP (the lowest level since 2005), and the household savings rate has risen to about 5 percent.
While the private sector — households and businesses — has made notable progress in lowering its debt burden, discussions of how to reduce public debt have only just begun. The government still needs to introduce major policy changes to put public debt on a sustainable path. Demographic trends (e.g. fewer Gen X’ers in the age bracket associated with maximum income earning and taxpaying) will make public debt reduction even more challenging.
It is necessary that the process of deleveraging plays itself out, which may take several more years. But keep in mind that economies that are deleveraging cannot grow as rapidly as they mightotherwise. That being said, we will likely see continued structural changes across the industry supply chain as we morph into the more compact and efficient green industry of the next decade. This will not only mean fewer key players in the industry but deeper,
more strategic relationships among those left in the aftermath of the transition.
Bottom line — we are not going to look the same as an industry in the future; not even close. That might not be a bad thing.