The Economic Recovery: Fast, Slow or Neither?

by Sudeep Reddy

Some Analysts Predict a Sharp Rebound While Others Foresee Sluggish Growth; a Few Say Another Slump Is Possible

The U.S. economy is pulling out of its deepest and longest recession since the Great Depression. Some economists expect a powerful recovery, others a sustained but muted one. Some even say it will be neither: a fleeting rebound quickly followed by a second slump.

For Americans beleaguered by almost two years of economic pain, the contours of the recovery will determine how many people linger without jobs, whether cutbacks to public services are restored and how quickly savings and investments gain value.

Economists trying to predict the shape of the recovery look for parallels in previous recessions. But the current downturn, which started in December 2007, has echoes from a multitude of economic slowdowns.

It featured the same kind of deep dive in economic output of the 1970s and 1980s recessions, which were followed by sharp rebounds. The credit shock from the latest downturn also recalls the milder credit headwinds of the early 1990s, which turned a relatively short recession into a slow multiyear recovery.

But what distinguishes this recession from most others before it is a severe credit contraction whose effects, some economists believe, are likely to linger for years.

Whatever the structure of the recovery, many consumers won't detect a change in their own circumstances. So many jobs have been lost that the unemployment rate will remain high when the economy begins to rebound. Large swaths of still-jobless Americans will have exhausted their severance payments and unemployment benefits, putting them under further strain even as the overall economy picks up again. And once consumers find new work, their depleted savings will leave them more vulnerable if they were to face another job loss in the next few years.

Some sectors of the economy — and regions of the country — are likely to recover earlier than others. The manufacturing and housing sectors, for instance, have contracted so deeply that they are likely to start recovering soon. But the troubled financial sector still is in the process of contracting as banks reshape their balance sheets, putting its recovery further down the road.

Facing a range of potential recovery scenarios, Americans are displaying everything from strong optimism to anxious caution. In recent months, investors have seemed hopeful about the prospects for a robust recovery, pushing stocks up more than 40% from their recession lows in March. Private-sector forecasters in the latest Wall Street Journal survey say the economy is starting to expand, but to expect slow to modest growth of between 2% and 3% next year. Most businesses remain hesitant, bracing for a painful year ahead.

After Steep Drop, a Sharp Rebound

The most common path for the economy after a severe contraction has been a huge rebound in economic activity. Employers usually slashed their payrolls and output so sharply to protect themselves, and consumers postponed so many major purchases during the worst of the downturn, that a return to growth came with a fierce expansion.

After the deep recessions of the 1970s and 1980s, business activity rebounded and within several months employers were rapidly rebuilding their payrolls. "You can't find a single deep recession that has been followed by a moderate recovery," said Dean Maki, chief U.S. economist at Barclays Capital. And most forecasters proved to be too pessimistic as prior deep recessions ended. "Very few people were looking for the kind of growth numbers that were actually printed," he said.

Forecasters who support the strong-rebound view expect the economy to grow at a 3% to 5% annual rate through the end of this year and provide the power needed to spark a longer-term recovery.

Businesses would ramp up output and hiring, restoring capital budgets for new computers and equipment. Rising stock values would help restore consumer confidence and spur additional spending for major goods such as cars and appliances. Some consumers put off key purchases for so long that eventually they must come around when they see good deals on store shelves. Housing construction also is coming off rock-bottom levels, giving the construction sector a bit more hope than it has had for the past three years.

After the natural rebound for three to six months, the bulk of the government's fiscal stimulus program would kick in. That would help sustain activity at the turn of the year and in early 2010, fully propelling the economy out of the downturn.

At Vila & Son Landscaping Corp. in Miami, incoming orders for new projects are about half the level they were at a year ago. The company, which has about 900 employees working on landscaping projects statewide, suffered as the construction and real estate markets tanked. The region has been left with huge inventory, from office rentals to condo buildings.

But the firm's president, Ricardo Leal, is adding workers for maintenance projects — while cutting back its construction operations — as it prepares for the economy to grow. He already sees signs of hope with more projects getting started in local governments, assisted-living facilities and parts of the health-care sector. "We've seen more activity from designers and landscape architects that are at the beginning of these projects," he said. "They feel like they're beginning to turn the corner. My gut tells me we're bottoming out right now and we'll start to see more activity going into 2010."

Economic Anxiety Keeps Growth Slow

The economy may bounce back, but plenty of barriers block the path to a sharp rebound. Trouble with spending and lending could potentially make the recovery a slog.

Consumer confidence is falling as job losses mount — albeit at a slower pace than before — and homeowners reshape their finances after severe declines in home values. Households are saving more than they have for most of this decade. That's suppressing consumer spending, the engine for 70% of economic output.

The credit shock is likely to impair the business and consumer sectors for years. Businesses are less likely to get easy loans as banks shrink their balance sheets. That's also true for homebuyers who are finding it harder to get new loans and would need to offer up larger downpayments. And, as real estate prices have tumbled, existing homeowners can't borrow against the value of their homes as they once did.

The credit headwinds "will continue to hang over the economy for a long time," said Nigel Gault, chief U.S. economist at Global Insight.

"It is one reason not to expect a strong recovery coming from the consumer side. It doesn't mean consumer spending won't grow, but it won't be a big leader the way it has been in previous expansions."

So after a quick bounce, proponents of the slow-growth view say the economy is more likely to expand at a 1% to 2% rate over the next year — well below the 4% to 5% that's necessary to heal the labor market after a deep downturn. Recessions caused by bursting bubbles like the recent housing collapse — as opposed to sharp rate increases by the Federal Reserve to thwart inflation — seem to be followed by jobless recoveries.

Businesses are finding ways to stretch their existing resources rather than expect a rebound.

"People are very frightened," said Janie Curtis, chief executive of Curtis Machine Co. in Dodge City, Kan., which makes gears and gear boxes. She says the end of the pain isn't in sight for her manufacturing customers whose sales are down 50% or more from a year ago. "When I ask people what they're seeing, they don't know either."

The payroll is down to about 70 employees from 200 several years ago, and Ms. Curtis isn't in a rush to hire more workers back. Instead, the firm is automating more of its operations, putting computers on every desk and squeezing more out of existing employees.

"Our productivity is way up, because the people who are left are having to work harder," Ms. Curtis says.

With a strong focus on productivity — remaining employees picking up the slack — some companies are likely to avoid rehiring workers as long as possible, keeping the rest on the jobless rolls even longer.

A Brief Rebound, Then a New Slump

The economy is likely to see a natural boost in the coming months from a rebound in production. After that, it will get some help from the bulk of the fiscal stimulus program late this year and early next year.

But then what?

The slack in the economy is so large that consumers won't see meaningful raises for years, and they will have less borrowing power to drive their spending. So consumers could make some of the big purchases they have been postponing and then close their wallets to save more.

Businesses, after a frightening period, could remain cautious about ramping up after a severe downturn. State and local governments could continue to cut back as tax revenue plummets. And the troubles aren't over for the banking sector. Foreclosures are still shooting up as loans go bad.

Once the boost from the federal government diminishes, the economy could still be without a major driving force such as consumer spending or business investment to push it forward — risking a return to its contractionary phase. After a brief six-month recession in 1980, the economy recovered but then relapsed within a year. Soaring inflation forced the Federal Reserve to raise interest rates to double-digit levels, pushing borrowing costs higher and spurring a painful and lengthy recession. The late 1940s and 1950s each saw recessions return just three years after the prior downturns ended. That is because businesses can bounce back from crises — such as wars — but then find that the recoveries aren't durable.

Today's fear is compounded by the heavy federal spending. Some economists worry high deficits will push interest rates — and borrowing costs — higher for consumers and businesses.

"I hope we don't have a double-dip recession, but that's a possibility," Ron Heaton, chief executive of the State Bank of Southern Utah. "The thing that no one knows is, will all this government spending, all this money being put into the system, bring inflation?"

Mr. Heaton's bank, which has about $600 million in assets, wasn't saddled with bad home loans. But it is dealing with added risks in commercial real estate, which many economists fear could drive another leg of the downturn as loans go bad, damage the banking sector and rein in lending even more.

"We don't have the demand that we had before," Mr. Heaton said, "which is probably good because we're working through some of those commercial real estate loans" that now look riskier.


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