Will This Recovery Really Be Different?

August 31, 2009

 Every business cycle some economists conclude that this cycle is different and that the economy will not rebound as vigorously as usual, but they are almost always wrong.    However, this recession was the worst any of us have ever experienced.  We got to the edge of the abyss.  And we got scared!  Is it possible that this recovery period really could be different?  After all, fear can do a lot to alter human behavior.  Will American consumers finally end their love affair with debt and excessive consumption and begin a long-lasting shift towards thrift? 

  One group of economists anticipates a protracted period of subpar growth, which they are calling “The New Normal”.   They may or may not be right, but they raise some interesting questions.

1.  Will home ownership still have its same appeal? Owning a home has always been an American dream, and home ownership has long been subsidized by the Federal government.  Homeowners deduct the interest they pay when calculating their taxes.  Below market rates of interest were readily attainable from Fannie Mae or Freddie Mac.  Credit was widely available, often with no down payment.  And apart from some scattered regional bubbles, homeowners have never seen their property value decline.  But in the past 18 months house prices have fallen by almost 25%.  One in twelve families are either behind on their payments on in foreclosure.  Does the fact that they can actually lose money on a real estate investment dampen the appetite of Americans for home ownership?  Or is this merely an opportunity for first time homeowners to purchase a home that they could not previously afford?
2.   How much will people save?  For the past 30 years property values have risen rapidly.  The stock market surged to ever new highs.  Wealth was rising rapidly.  There was no need for additional savings.  As a result, the savings rate – the amount that we save from our paycheck – fell to zero.  But now, trillions of dollars of household net worth has been destroyed.  The unemployment rate is approaching 10%.  People are postponing retirement.  Retirees are going back to work.  Others are taking second jobs.  There is a definite need to save.  The savings rate has recently climbed back over 5%.  How high will it go?  If it stays at 5% that means there will be 5% less consumption spending going forward.  If it rises further, the bite will be even bigger.
3.  When will banks make credit more readily available to consumers and small businesses?  Bank capital has been eroded by defaults on mortgages and credit card debt, and by the declining value of securities tied to these debt instruments.  Banks are currently far more interested in raising capital than they are in making new loans.  As a result of balance sheet erosion, banks have tightened credit conditions by requiring bigger down payments and higher credit scores.  Only the most creditworthy borrowers are able to secure funds in today’s environment.  But if the economy is going to grow, lenders need to open the spigot. 
4.  When will businesses boost capital spending?  Several factors have to emerge before that can happen.  First, corporate America needs to return to profitability.  Thus far, profits have beaten analysts’ expectations largely because of aggressive cost cutting.  But there is a limit on how far that can go.  For earnings to grow further there needs to be growth in revenue which is, in turn, dependent on jobs and growth in income.  That has not happened yet.  Second, production is beginning to pick up, but only because firms have slashed inventory levels so sharply.  That will be a temporary blip unless businesses see a sustainable pickup in sales.  But sales, like earnings, are dependent upon growth in jobs and income.  Third, the utilization rate needs to rise from its current level of 65 per cent.  In normal circumstances it would be about 80 per cent.  There is considerable unused capital equipment sitting on the factory floor and little need for more.  For a sustainable recovery, we need businesses to jump back into the game.

The answers to these questions will determine the breadth and vigor of the coming recovery.