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US recovery? Keep the bubbly on ice

Financial markets and the so-called Davos consensus are in broad agreement that something close to a classic cyclical revival may finally be at hand for the United States. But is it?

In the 17 quarters since ‘recovery’ began, annualised growth in real personal consumption expenditures has averaged only 2.2 per cent. PHOTO: REUTERS

In the 17 quarters since ‘recovery’ began, annualised growth in real personal consumption expenditures has averaged only 2.2 per cent. PHOTO: REUTERS

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Financial markets and the so-called Davos consensus are in broad agreement that something close to a classic cyclical revival may finally be at hand for the United States. But is it?

At first blush, the celebration seems warranted. Growth in real Gross Domestic Product (GDP) appears to have averaged close to 4 per cent in the second half of last year, nearly double the 2.2 per cent pace of the preceding four years. The unemployment rate has finally fallen below the 7 per cent threshold. And the Federal Reserve has validated this seemingly uplifting scenario by starting to taper its purchases of long-term assets.

But my advice is to keep the champagne on ice.

Two quarters of strengthening GDP growth hardly indicates a break-out from an anaemic recovery. The same thing has happened twice since the end of the Great Recession in mid-2009 — a 3.4 per cent average annualised gain in the second and third quarters of 2010, and a 4.3 per cent average increase in the fourth quarter of 2011 and the first quarter of 2012.

In both cases, the uptick proved to be short-lived.

A similar outcome this time would not be surprising. Indeed, much of the acceleration in GDP growth has been bloated by an unsustainable surge of restocking. Over the first three quarters of last year, rising inventory investment accounted for fully 38 per cent of the 2.6 per cent increase in total GDP.

Excluding this inventory swing, annualised growth in “final sales” to consumers, businesses and the government averaged a tepid 1.6 per cent. With inventory investment unlikely to keep accelerating at anything close to its recent rate, overall GDP growth can be expected to converge on this more subdued pace of final demand.


That gets to the toughest issue of all — the ongoing “balance-sheet recession” that continues to stifle the American consumer.

Accounting for 69 per cent of the economy, consumer demand holds the key to America’s post-crisis malaise. In the 17 quarters since “recovery” began, annualised growth in real personal consumption expenditures has averaged only 2.2 per cent, compared with a pre-crisis trend of 3.6 per cent from 1996 to 2007.

To be sure, there were indications of a temporary pick-up in annual consumption growth to nearly 4 per cent in the fourth quarter of last year. However, that is reminiscent of a comparable 4.3 per cent spurt in the fourth quarter of 2010, an upturn that quickly faded.

The lacklustre trend in consumption is all the more pronounced when judged against the unprecedented decline that occurred in the depths of the Great Recession.

From the first quarter of 2008 to the second quarter of 2009, real consumer spending plunged at a 1.8 per cent average annual rate. In the past, when discretionary spending on items such as motor vehicles, furniture, appliances and travel was deferred, a surge of “pent-up demand” quickly followed.

Not this time. The record plunge in consumer demand has been followed by persistently subpar consumption growth.


This should not be surprising. The American consumer was, in effect, ground zero in this horrific crisis.

Far too many US households made enormous bets on the property bubble, believing that their paper gains were permanent substitutes for stagnant labour income. They then used these gains to support a record consumption binge.

Compounding the problem, they drew freely on a monstrous credit bubble to finance the gap between spending and income-based saving.

When both bubbles burst — first housing, and then credit — asset-dependent US consumers were exposed to the American strain of the Japanese disease first diagnosed by Nomura economist Richard Koo.

Mr Koo has stressed the lingering perils of a balance-sheet recession centred on the corporate sector of the Japanese economy; but the analysis is equally applicable to bubble-dependent US consumers.

When the collateral that underpins excess leverage comes under severe pressure — as was the case for Japanese businesses in the early 1990s and American consumers in the mid 2000s — what Mr Koo calls the “debt rejection” motive of deleveraging takes precedence over discretionary spending.

The Japanese parallels do not stop there. As research by the economists Richard Caballero, Takeo Hoshi and Anil Kashyap has shown, Japan’s corporate “zombies” — rendered essentially lifeless by their balance-sheet problems — ended up damaging the healthier parts of the economy.

Until balance sheets are repaired, such “zombie congestion” restrains aggregate demand. Japan’s lost decades are an outgrowth of this phenomenon; the US is now halfway through the first lost decade of its own.

Indicators of US balance-sheet repair hardly signal the onset of the more vigorous cyclical revival that many believe is at hand.

The debt/income ratio for American households is now down to 109 per cent — well below the peak of 135 per cent reached in late 2007, but still 35 percentage points above the average over the final three decades of the twentieth century.

Similarly, the personal saving rate stood at 4.9 per cent late last year, up sharply from the low of 2.3 per cent in the third quarter of 2005; but it remains 4.4 percentage points below the average recorded from 1970 to 1999.

By these measures, American consumers’ balance-sheet repair is, at best, only about half-finished.


Optimists see it differently. Encouraged by sharp reductions in households’ debt-service costs and a surprisingly steep fall in unemployment, they argue that the long nightmare has finally ended.

That may be wishful thinking. Plunging debt service is largely an outgrowth of the Fed’s unprecedented zero-interest-rate policy. As long as the stock of debt remains excessive, consumers will dismiss the reduction in interest expenses as nothing more than a temporary subsidy from the Fed.

Moreover, the decline in unemployment largely reflects persistently grim labour-market conditions, which have discouraged many workers from remaining in the labour force.

If the labour-force participation rate was 66 per cent, as it was in early 2008, rather than 62.8 per cent, as it was last month, the unemployment rate would be just over 11 per cent, not 6.7 per cent.

Yes, there has been some progress on the road to recovery. But, as economists Carmen Reinhart and Ken Rogoff have long documented, post-crisis healing is typically slow and painful. Notwithstanding the Fed’s claims that its unconventional policies have been the elixir of economic renewal in the US, the healing process still has years to go. PROJECT SYNDICATE


Stephen S Roach, a faculty member at Yale University and former Chairman of Morgan Stanley Asia, is the author of the new book, Unbalanced: The Codependency Of America And China.

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