Thursday, July 9, 2009

What Will the Recovery Look Like (assuming there is one)

Robert Reich says (emphasis mine):

The so-called "green shoots" of recovery are turning brown in the scorching summer sun. In fact, the whole debate about when and how a recovery will begin is wrongly framed. On one side are the V-shapers who look back at prior recessions and conclude that the faster an economy drops, the faster it gets back on track. And because this economy fell off a cliff late last fall, they expect it to roar to life early next year. Hence the V shape.

Unfortunately, V-shapers are looking back at the wrong recessions. Focus on those that started with the bursting of a giant speculative bubble and you see slow recoveries. The reason is asset values at bottom are so low that investor confidence returns only gradually.

That's where the more sober U-shapers come in. They predict a more gradual recovery, as investors slowly tiptoe back into the market.

Personally, I don't buy into either camp. In a recession this deep, recovery doesn't depend on investors. It depends on consumers who, after all, are 70 percent of the U.S. economy. And this time consumers got really whacked. Until consumers start spending again, you can forget any recovery, V or U shaped.

Problem is, consumers won't start spending until they have money in their pockets and feel reasonably secure. But they don't have the money, and it's hard to see where it will come from. They can't borrow. Their homes are worth a fraction of what they were before, so say goodbye to home equity loans and refinancings. One out of ten home owners is under water -- owing more on their homes than their homes are worth. Unemployment continues to rise, and number of hours at work continues to drop. Those who can are saving. Those who can't are hunkering down, as they must.

My prediction, then? Not a V, not a U. But an X. This economy can't get back on track because the track we were on for years -- featuring flat or declining median wages, mounting consumer debt, and widening insecurity, not to mention increasing carbon in the atmosphere -- simply cannot be sustained.

The X marks a brand new track -- a new economy. What will it look like? Nobody knows. All we know is the current economy can't "recover" because it can't go back to where it was before the crash. So instead of asking when the recovery will start, we should be asking when and how the new economy will begin. More on this to come.

I certainly agree that there's a low (close to zero) probability that we will see a "V" shaped recovery. Consumers are loaded with debt, including those with negative equity in their houses, and so are companies.

I'm more in the "U" camp, although I don't the letter accurately describes my position given I don't expect a slow recovery that eventually becomes gangbusters. Reich does not do justice to the position and makes what I believe is a somewhat logical misstep. He correctly points out the reasons why a "V" does not appear likely, but that does not mean a slow recovery that features GDP growth below "potential" but non-zero and eventually easing unemployment numbers. Consumers and firms are in trouble, but that may ease and lead to a slow but not an absolutely terrible economy. Conditions may slowly improve because people and companies recover from their poor boom-time decisions.

I stress may because, as I noted in an earlier post, there are still dangerous obstacles to overcome. California and other states, corporate real estate, decreasing help from the stimulus, to name a few. I think the most probable outcome is slightly positive growth for a the foreseeable future. I agree there is a real chance we take one or more nose dives before this is over and don't see how there will be a rapid recovery. Just because there are problems that limit future growth, does not mean we "can't 'recover.'"

I agree with Professor Reich that the economy has reached an inflection point. To grow the way we want to and to open up the economy to more people, we are going to have to find a new source of growth. That does not mean we can't have the slow growth I've mentioned for what seems like the 100th time without changing much. But to get true robust and substantial growth that will lead to better lives and lower poverty, somethings has to give.

Finally, just like the Great Depression affected they way my Grandparents spent money and invested, I think my generation will be scared by this mess (though less so than my mattress stuffing Grandparents). Its sounds pretty good right now that my peers may have been scared into more responsible saving and investing than my parents generation, but that is not necessarily so. Will it still sound good in a few years if we recover from catastrophe and people are complaining that investors are too risk adverse and our economy is not reaching its potential? Also, I'm not sure how lasting the effect will be. It sounds reasonable to say few will want to touch the ARM's, MBS's, covenant light, etc for a long time. However
, it also seems reasonable to say new, yet-to-be-toxic "innovations" will come along and my generation has gotten used to a certain level of luxury and will forgo responsibility. This will leave an impression on us all, and I doubt we will return to the debt crazed glory days for quite sometime. Then again, we should never underestimate the American consumer.

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