A long with the alphabet soup associated with the description of the US economic recovery has been thrown in some math, what with “V”, “U”, “L” shaped and “square root” recoveries suggested, economist Nouriel Roubini’s opinion piece the Financial Times on 24 August brought the “W” back into the discussion.
The stock market, on the other hand, seems to be pricing in an I-shaped recovery!
Since forecasting makes the forecaster look foolish more often than not, we are not going to attribute a shape to the economic recovery and we certainly are not going to put a number to future gross domestic product, or GDP, growth, but we will try to put together a convincing framework to our argument that the economic recovery, if any, is going to be tepid.
With about 70% of the US GDP coming from consumer spending, the consumer has to be the central point of any analysis and it’s a given that if consumers go into a shell, economic growth is going to suffer.
If we look at the two ways in which consumers traditionally spend—from their wages or from reserves put away over the years, it can clearly be seen that the American consumer will see both avenues shut.
The transition will have to be made to Americans spending less, saving more, building their battered balance sheets and producing more—and this period of transition will not be easy.
At the end, however, you will have a more balanced economy which relies less on consumer spending, imports less, exports more and relies less on foreign financing.
The consumer’s net worth had seen an unprecedented rise over the last decade; consequently the asset deflation we’ve seen has led to an unprecedented and unrelenting erosion of net worth. Home prices were of unparalleled significance because all the growth in consumer spending, if not more, was coming from borrowing against the rising home prices but the US consumer is almost twice as exposed to the stock market.
When virtually all your savings are in such retirement plans or your home, erosion of this value can have a devastating effect on spending psyche.
Data is hard to come by, but we wouldn’t be surprised if an entire generation has moved away from the stock market, and consequently hasn’t taken full advantage of the recent stock market rally.
The housing market, meanwhile, continues to be oversupplied and overvalued. Recent data superficially suggests sales are picking up, however, these are at the very low end of the market sparked by continuing foreclosures and a $8,000 (around Rs3.9 lakh) federal credit for first-time homebuyers. This rebate expires soon and will have a telling impact.
The widely watched Case-Shiller index of home prices suggests that prices went up in the second quarter. However, the index isn’t seasonally adjusted and the US is notorious for housing transactions being heavily tilted towards the spring and summer months.
Debt paydown by the US consumer also continues—be it credit card debt or mortgages. As we have said in the past, the credit contraction is less of a bank lending issue and more of a borrowing capacity issue on the part of the consumer, as the percentage of the consumer’s income going towards debt service was reaching unprecedented highs. If the consumer can’t borrow, it reduces demand for the very assets that the consumer holds and net worth further suffers.
This will continue until debt service ratios are substantially lower.
The job losses, meanwhile, though off their peak levels, continue unabated. Some of the recent improvement, albeit cheered by the markets, has come from temporary federal census worker hiring. The wildly popular “cash for clunkers” programme has also distorted the employment and wage picture temporarily. Besides this, the structural decline of real wages that started before the recession continues. And let’s not forget the last economic recovery was a jobless one—a similar scenario this time will only exacerbate the pain.
The two structural changes that are necessary are: consumers deleveraging their balance sheets to clear out years of excesses and the US regaining some of its old goods producing prowess. This will mean that the economy tilts slightly away from consumer spending to a slightly more goods producing focus.
This will be the ultimate solution to America’s current account deficit problem and external financing needs. However, positive this structural shift is over the long term, it means tepid economic growth for the next few years.
Rajeshree Varangaonkar and Bharat Indurkar have day jobs with US-based hedge funds. They write every other Friday. Send your comments to firstname.lastname@example.org