The $12 trillion (Rs598.8 trillion) contraction in US wealth and the end of mortgage equity withdrawals suggest consumption should decline by 7.6% of gross domestic product (GDP). That, offset somewhat by a balance of payments improvement, would lead to a peak-to-trough real GDP decline of 4-5%. That is much deeper than implied by the 0.8% decline the Organisation for Economic Cooperation and Development (OECD) currently forecasts for 2009.

US GDP declined a revised 0.5% in the third quarter of 2008, primarily due to a 3.7% annualized fall in personal consumption expenditures. The price index for gross domestic purchases increased by 4.7% during the quarter.

US housing wealth has declined by approximately $4.6 trillion since 2006, according to the Case-Shiller index. US stock market wealth has declined by $7.9 trillion since October 2007. Thus, total US wealth has declined at least $12 trillion.

Typically, consumption falls by 5% of such a decline in wealth, as poorer-feeling individuals rein in spending. That would lead to a fall in consumption of $600 billion annually.

In addition, the boom was also fuelled by mortgage equity withdrawals, which peaked at $750 billion in 2005. About two-thirds of this was spent on consumption. That suggests a total peak-to-trough consumption decline of about $1.1 trillion, 7.6% of the current GDP of $14.4 trillion.

The US savings rate is currently 1.6% of personal income. Reversion to the 50-year average of around 8% would require a consumption decline of 6.4% of personal income or 5.4% of GDP.

Thus, the likely decline in consumption should push the savings rate temporarily above its long-term average, allowing wealth to be rebuilt.

Two factors offset this. First, the US balance of payments deficit is $700 billion annually. Analysts have estimated that no more than $250 billion annually is sustainable, so a swing of $450 billion, or 3.2% of GDP, is needed. Second, a stimulus package of $300 billion annually would add about 2% to GDP.

A consumption decline of 7.6% of GDP, offset by an increase in net exports of the whole 3.2% of GDP, would reduce GDP by 4.4%.

A stimulus package could improve this picture, but would be offset by deterioration in the US payments position as foreign investors bought more treasuries.

Overall, a GDP decline of 4-5%, peak to trough, seems likely. In that case, the drop in 2009 GDP would be much more than 0.8%. The OECD is overoptimistic.