Back blogging! Recovery? Even Krugman?

Well I'm back. No real progress on the thesis but i did spend a lot of time following the election and the economic crisis, learning a lot in both areas. I also reread my initial posts. A fair amount of needless commentary (some of it just junk!) in them. I'll clean it up over time and try to make it more useful from a lay perspective. I was a little exuberant (OMG giddy?) to say the least when I first started the blog.

Well since my last post in August of 2007, we've had a heck of a recession, pretty much world-wide. According to NBER (the National Bureau of Economic Research one of whose functions is to define when recessions begin and end in the US) the recession began in December of 2007, but really gathered steam (ice) in the last quarter of 2008 and the 1st quarter of 2009, with the US economy shrinking by about 1.5% (close to 6% annualized) in each quarter (versus the respective prior quarter). However, the economy was down by only 0.3% (1% annualized) in the 2nd qtr. of 2009, as it appears the Federal stimulus (among other factors) has started to help slow the slide. In the meantime unemployment went from about 5% in December 2007 to 9.5% in June 2009, and is expected by many economists to pass 10% by the end of this year, even with the stimulus.

But beginning this Spring there has been an increasing chorus of pundits predicting that the economy will start growing this Summer. This (recently) included Paul Krugman. Nothing wrong with that, and Prof. Krugman is much more realistic about the long-term prospects (slow) than most. In fact we might very well show some positive economic growth this (3rd) quarter. Consumer spending (70% of the economy) is not robust, but the cash for clunkers program has spurred some increase in automotive sales. Further, residential housing sales are up, aided by dropping prices and the housing purchase rebate (scheduled to expire in November). And the $ amount of stimulus will continue more or less at a similar level (about 2.5%) of GDP as the 2nd Qtr. So all told (and including additional production to build inventory of goods back up), this might be enough to show positive economic growth this Qtr. AND THEN?

The problem is that consumer spending after adjusting for inflation (personal consumption-see the bureau of economic analysis June personal consumption) , has been essentially flat since the initial and significant drop in the 2nd half of 2008. IN SPITE OF or better said, INCLUDING the government stimulus. My concern is that as businesses realize that consumption (Sales) in fact will continue slow (not growing) for several years, layoffs will (re)accelerate, causing a further dip in consumption (and perhaps a further decrease in business investment) and therefore a second leg down in the economy (the so-called double dip recession) later this year and into 2010. This would clearly call for a more robust (and job-directed) stimulus, but no way in H the current political environment will allow it. A little (a lot?) like the situation in 1930-32 or 1936 during the great depression.

Regarding the American consumer much has been made of the fact that the savings rate (% of net income saved) went from around zero a couple of years ago to 5-6% at the end of 2008 and in the first half of this year. Presumably because consumers lack confidence and are preparing for the worst by spending less and saving more. So, based on this the key question is, as they regain confidence will they start spending more in the near future to support an economic recovery?

In my view they won't spend more, not because of a lack of confidence, but because of a lack of MONEY to spend. Between 1999 and 2007 the debt of American consumers (mortgage, home equity loans, installment loans such as cars and furniture and credit cards) more than DOUBLED!!, to about 100% of GDP. In other words many (but many did not) consumers spent their earnings and then borrowed money to spend even more, which produced negative savings for this group. But then the housing bubble burst and banks began to decrease lending, so these same consumers had to cut their spending to match their incomes, less some more to reduce their debts.

So let's assume that 2-4 years ago, on average 50% of consumers (group A) spent what they earned plus 10% more, borrowed from banks (which means a negative savings rate of 10%). And the other 50% of consumers (group B) saved 10% of what they earned (spending the rest every year). If you average the two groups together, the savings rate is 0. So let's say today group B keeps saving 10% of their earnings. And group A keeps spending all they earn, but CAN'T borrow from the bank, so their savings rate is 0, but not negative as in the past. Now if we average the two together we get an overall savings rate of 5%.

So where will increased spending come from? Group A can't spend more, unless the banks lend them more, and the banks want to get paid back, not lend more. And group B has been sensibly saving for retirement in the past, so why would they change now? This is what economists call the BALANCE SHEET problem, meaning too many consumers have too much debt and too few assets. Until the debt gets significantly reduced there is unlikely to be any significant increase in consumer spending.