The Godot Recovery
By Patrick O'Keefe
When the economy finally begins expanding, it should be dubbed the “Godot Recovery” – one whose arrival was long-awaited, oft-predicted, and endlessly delayed.
What is already the longest recession in 70 years looks to continue through the summer. There are, however, signs that the downward trend is losing momentum. Job losses are slowing; consumer spending has stabilized; housing has bottomed; and the manufacturing sector is near the end of its massive inventory liquidation. Further, the corporate sector has returned to profitability, due largely to the impact of low interest rates on the financial sector’s bottom line.
These are all positive developments. But they indicate a slowing in the rate of contraction, not the beginning of an expansion. Godot may be closer, but we are still awaiting his arrival.
It was not until December 2008, fully a year after the event, that the National Bureau of Research (NBER) announced that the nation’s economy had slipped into recession. It may take NBER even longer to lower the curtain on the contraction.
The delays are not due to procrastination, but rather to the economy’s complexity and dynamism. Even under “normal” conditions, its interdependent components are in constant flux, changing absolutely and relative to each other.
Since these components often move at different rates and even in different directions, no one statistic can be relied upon to gauge whether the general economy is expanding or contracting. Instead, NBER weighs several factors (including, inter alia, total output, after-tax incomes, employment, sales, and industrial production).
No matter what else can be said about this downturn, it has been anything but “normal.” Resolving its underlying causes will entail structural shifts within virtually every element of the economy as well as changes in the interactions among sectors. These adjustments, some already well along, will alter the behavior of households, businesses, and governments as they grapple with the legacy of a decade-long borrowing binge.
At the end of 2008, the outstanding debt of the U.S. economy’s nonfinancial sectors (households, nonfinancial businesses, and governments) totaled $33.5 trillion. Over the course of this decade, debt increased by 94 percent. In other words, Americans borrowed almost as much in nine years as in the nation’s first 200.
Every sector increased its debts but households accumulated the lion’s share, more than doubling (+115 percent) their indebtedness during the decade. The added borrowing was concentrated in mortgages,which are long-term obligations secured by assets whose value has declined.
Debt is a pledge of future income. Like Popeye’s friend Wimpy, borrowers promise to “gladly pay Tuesday for a hamburger today.”
For households (i.e., consumers), Tuesday has arrived. It’s time to pay for yesterday’s hamburgers, which means delaying (or even forgoing) purchases in the days to come.
Since consumers account for more than 70 percent of gross domestic product, even relatively small changes in their behavior can alter the economy’s size and vitality, as was made evident over the past year.
From the mid-1990s until recently, American households reduced their savings. During the first half of the 1990s, savings averaged 6.5 percent of after-tax incomes. By the first quarter of 2008, only 0.2 percent of after-tax incomes was saved.
But a weakening economy and wobbly balance sheets compelled households to shift from spending to saving (including debt reduction). In the first quarter of this year, the savings rate rose to 4.4 percent – an annualized net increase of $455 Billion – and spending on goods and services fell. (Because after-tax incomes rose, the decline in spending was less than the increase in savings.)
Eventually savings, when productively invested, become the foundation of future growth. But that will take time given the mountain of debt that accumulated over the past decade. In the interim, stimulative fiscal and accommodative monetary policies will counter the drop in consumer spending, at least in part.
As noted above, only months after the fact will NBER certify that the economy has stopped shrinking. But a statistical “bottom” is not tantamount to the start of a rebound.
Instead, after a decade-long borrowing binge, the bottom is likely be followed by a period of sluggish activity, with some sectors expanding, some stagnant, and others shrinking.
The next phase of the cycle will not be a recession in the technical sense but neither will it be a rebound in the common sense. It will be a period of subdued performance, better than the past 18 months, but not a robust, v-shaped recovery.
It play out to a different script, one focused more on investing in the future and less on borrowing against it. But in this slow-growth sequel, Godot arrives.
Patrick O’Keefe is director of economic research at J.H. Cohn LLP. He can be reached at pokeefe@jhcohn.com or 973-364-7724.