Brace for an era of crisis aftershocks

By David Rosenberg, Financial Times

Here is the reality. We have intense uncertainty on US fiscal, energy and health policies. Nobody knows what their effective tax rate is going to be next year so they cannot plan.

When you model that uncertainty in economic terms, you end up with higher liquidity ratios in business and rising savings rates in the personal sector. This damps spending growth and spending is what gross domestic product is all about.

Now, if the baseline growth trend in the US economy was in the old paradigm range of 4-6 per cent for this stage of the cycle, we could certainly absorb these negative shocks.On top of that, we have an export shock from the spreading European recession that is only now starting to show through in the data, such as the plunge in US purchasing managers’ orders.

But the underlying trend in the pace of economic activity is somewhere between 1 and 2 per cent, so there is little margin for error: the cushion is razor-thin.

After almost four years of $1tn-plus fiscal deficits, near-zero policy rates, and a Fed balance sheet that is pregnant with triplets, how can we not have some growth, any growth?

The government spigots have been turned on to such an extent that if this were a normal plain-vanilla cycle, the economy would have ballooned at an 8 per cent average annual rate since the “great recession” ended three years ago.

The fact that it has expanded at barely more than a 2 per cent pace – the weakest recovery ever – speaks to the secular headwinds from debt-burdened households, structural unemployment and retrenchment at state and local government level.

Indeed, the recession may well have ended in June 2009, but the problem is that there was no recovery to speak of. Lingering excess supply in the labour market has led to a 5 per cent decline in real median incomes over the past three years.

The necessity of crawling out of excess indebtedness has led to the mother of all deleveraging cycles: the aggregate household debt/income ratio has contracted from the bubble-high 134 per cent in 2007 to a nine-year low of 114 per cent. That is an unprecedented 20 percentage point decline in five years.

And what makes this cycle a totally different animal to anything we have seen in the past is the destruction of wealth.

The Fed told us recently that median household net worth collapsed an epic 39 per cent from 2007 to 2010. That is a depression statistic.

And this is what, shamefully, the economics community has totally missed: the effects, the scars if you like, will linger for a long time.

This wealth collapse was the equivalent of an earthquake measuring 7 or 8 on the Richter scale, and earthquakes are followed by aftershocks, which is exactly what has provided the biggest hurdle for the post-recession healing phase we have been in for the past three years.

It takes time for a slump in household net worth to register fully. As such, there are lags between the event and the drawn-out but profound impact on consumer spending patterns, as frugality emerges as the new and lasting fashion.

The baby boomers, who are now entering their mid-60s and the group that was at the epicentre of this tragic collapse in net worth, are still in the process of recalculating their ability to retire when they thought they could at the bubble highs. They have lowered their expectations of what their living standards will look like when they do stop work.

So the era of the aftershock is what we are in and what we will probably stay in for years to come.

That means consumer behaviour and patterns will undergo profound and enduring changes that will prove to be intensely disinflationary and foster a prolonged period of ultra-low interest rates, bond yields and expected returns in the public capital markets.

I remain of the view that the secular bull market in Treasuries does not come to a complete end until the long bond goes all the way back to its early 1940s low of 2 per cent, so there is still a hefty 65 basis points of rally left in this monster.

This will make spread product an attractive way to pick up a yield premium at the lows and mean dividend themes stay prevalent in the equity market.

The scars from the detonation of the housing and credit bubble-bust have yet to heal.

Household net worth per capita is still 15 per cent or $100,000 shy of where it was five years ago and ultra-low interest rates are punishing those who save in bank deposits or money market funds.

The median age of the boomer is 55 going on 56 and retirement is the darkness at the end of the tunnel.

The trend towards second jobs, do-it-yourself, private labels, dollar stores, maintaining your existing vehicle, downsizing property needs, cocooning and frugality will continue unabated.

The boomer age of narcissism is over, but look at the bright side: I’ve never met a Buddhist who wasn’t completely tranquil and ... happy.

David Rosenberg is chief economist and strategist of Gluskin Sheff

The Worst Economic Recovery in History

By EDWARD P. LAZEAR, WSJ

How many times have we heard that this was the worst recession since the Great Depression? That may be true—although the double-dip recession of the early 1980s was about comparable. Less publicized is that our current recovery pales in comparison with most other recoveries, including the one following the Great Depression.

The Great Depression started with major economic contractions in 1930, '31, '32 and '33. In the three following years, the economy rebounded strongly with growth rates of 11%, 9% and 13%, respectively.

The current recovery began in the second half of 2009, but economic growth has been weak. Growth in 2010 was 3% and in 2011 it was 1.7%. Who knows what 2012 will bring, but the current growth rate looks to be about 2%, according to the consensus of economists recently polled by Blue Chip Economic Indicators. Sadly, we have never really recovered from the recession. The economy has not even returned to its long-term growth rate and is certainly not making up for lost ground. No doubt, there are favorable economic numbers to be found, but overall we continue to struggle.

During the postwar period up to the current recession (1947-2007), the average annual growth rate for the U.S. was 3.4%. The last three decades have experienced somewhat slower growth than the earlier periods, but even in the period 1977-2007, the average growth rate was 3%. According to the National Bureau of Economic Research, the recovery began in the second half of 2009. Since that time, the economy has grown at 2.4%, below our long-term trend by either measure. At this point, the economy is 12% smaller than it would have been had we stayed on trend growth since 2007.

Worse, the gap is growing over time. Today, the economy is four percentage points further from the trend line than it was the first quarter of 2009 when this administration's nearly $900 billion fiscal stimulus efforts began. If forecasts of around 2% growth turn out to be accurate, we will add to that gap this year.

Contrast this weak growth with the recovery that followed the other large recession of recent decades. In the early 1980s, the economy experienced a double-dip recession, with contractions in both 1980 and '82. But growth rates in the subsequent two years averaged almost 6%. The high growth that persisted throughout the 1980s brought the economy quickly back to the trend line. Unlike the current period, from 1983 on, the economy was in rapid catch-up mode and eventually regained all that had been lost during the early '80s.

Indeed, that was the expectation. As economist Victor Zarnowitz of the University of Chicago argued many years ago, the strength of the recovery is related to the depth of the recession. Big recessions are followed by robust recoveries, presumably because more idle resources are available to be tapped. Unfortunately, the current post-recession period has not followed the pattern.

The 2007-09 recession was induced by a financial crisis and some, most notably economists Carmen Reinhart and Kenneth Rogoff (authors of "This Time is Different: Eight Centuries of Financial Folly"), argue that financial crises pose more difficult recovery problems than do policy-induced recessions.

The early '80s recession could be viewed as induced by the Federal Reserve's tight monetary policy (i.e., raising interest rates), which was designed to rein in inflation. Growth returns more rapidly, they argue, when the policy hindering it changes (i.e., the Fed lowers interest rates) than when the economy is struggling after a severe credit crisis like the one we experienced after the 2008 collapse of Bear Stearns.

But some, Stanford economist John Taylor being their leading spokesman, argue that the current recession was caused by Fed policy as well—rates remained too low for too long in the lead up to the subprime mortgage fiasco. The Great Depression also began with a financial crisis but saw high growth rates following contractionary years, and the output lost in negative years was eventually regained through higher subsequent growth.

Are there other factors that may have contributed to the slow recovery that we are experiencing? It would be difficult to argue that government polices over the past three years have enhanced confidence in the U.S. business environment. Threats of higher taxes, the constantly increasing regulatory burden, the failure to pursue an aggressive trade policy that will open markets to U.S. exports, and the enormous increase in government spending all are growth impediments. Policies have focused on short-run changes and gimmicks—recall cash for clunkers and first-time home buyer credits—rather than on creating conditions that are favorable to investment that raise productivity and wages.

There are some positive developments. The labor market is improving, albeit slowly. Profits remain high and the stock market has enjoyed some recent success. We can hope that these indicate better times and higher growth ahead. But unless we move to a set of economic policies that are aimed at growing the economy rather than at promoting social agendas, this may be the first "recovery" in history that fails to see us return to long-term average growth.

Mr. Lazear, chairman of the President's Council of Economic Advisers from 2006-2009, is a professor at Stanford University's Graduate School of Business and a Hoover Institution fellow.