On Friday there was a general reaction to the jobs report by most of the talking heads on television that the numbers indicated that the worst part of the recession (the decline) was over and we were either at the bottom, near the bottom, or already on the way up. In fact the most optimistic of the the analysts started talking about a V shaped recovery.
While I do believe that it is possible that the worst is over, I think that caution is appropriate. There were two major sources of wealth for Americans that were severely battered.
The first of these, but not the most important, was the stock market. This is of course a very significant source for many Americans but the majority of the Americans who participate in the market do so passively via 401ks and other retirement plans. It is a very small number of people who actively invest. It is probably fairly safe to say that many of the losses to these individuals impacted their retirement plans and many likely moved assets from the stock market into low yielding cash investment funds where they could. The upturn in the market most likely is not a major source of spending power and many of these individuals are diverting more money into savings to try to repair their retirement funds.
The second source of wealth for most Americans and this was the one that was most significant, was housing. As housing prices increased, many Americans were able to tap those funds to pay for purchases. They did this via refinancing or equity loans and bought all sorts of consumer items that effectively drove the economy. Further, knowing they had a pent up source of wealth, they felt more comfortable in using credit cards and in fact credit card companies were very comfortable if offering home owners more and more credit. This source of wealth has for the most part not recovered and is unlikely to recover any time soon. Without it, consumer spending is not going to return to prior levels. It can't, the money and credit simply don't exist.
So what does this mean for the recovery? The recovery will have to be built on a more fundamental and lower level than we had in the past. Without a surge in consumer spending, and such a surge is effectively impossible, economic activity will improve but only very slowly. People who do buy housing at the new lows will probably start to see some modest price appreciation, but the majority of American homes are still owned by the same people who owned them a few years ago. They may already be heavily mortgaged and if not, the owners have less equity in them then they did previously and are much less likely to tap that equity after seeing the recent economic meltdown. Banks are also not going to provide credit as easily as they did.
So without a surge in consumer spending, hiring will continue at modest levels. This will create market pressures that keep wage increases low and continue a drain of social services for the unemployed. To a large extent many baby boomers, who would potentially have left the labor force and lived on their investments and equity increases, will stay in the labor force and reduce opportunities for new employment.
The good news is that inflation is extremely unlikely since demand is simply not going to return to prior levels. Many of the forecasts I heard yesterday were simply ill informed at best. Discretionary income for Americans has not had a dramatic reduction. More of it has been diverted to savings but the recession and demand reduction is driven by the loss of wealth and credit, not a reduction in income. Yes, there are many unemployed, but the benefits they receive and in many cases the reduction in expenses, such as mortgage payments, leave them with nearly the same discretionary income they had previously. However, they have no source with which to pay for major items, i.e. home improvements, cars, boats, vacations, etc.
I saw an article in one of the publications I read about how young families, who had lost jobs and homes, were coping with the crisis by moving in with their parents. The article highlighted a specific family, but let's consider the impacts of this trend. The young folks would most likely want to save where possible so they could eventually buy a house again. Of course, they also need to find employment. Household expenses for a larger group do go up, but they don't go up to the levels that two households generate. So both before and after they find employment they are most likely going to spend much less than previously. Of course they will have to increase spending when they get employment but if hiring is going to be as slow as I believe it will be, this may take quite a while.
The central point I am making with the example above is that Americans will find a way to cope by reducing expenses, doubling up on housing and being more prudent. These are good changes from a long range perspective but they will not produce a rapid rebound in the economy. We should be prepared for a significant period of slow growth based on a more sustainable economy. However, the slow growth will mean that we will have more unemployment, less opportunities for new entrants and people working longer than they expected to a few years ago. At least that part may reduce some demand on our Social Security System.
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