Photo: National Archief via Flickr
The major problem with the economy is that consumers are not spending as a result of the record household debt built up over the last few decades. Until this huge amount of debt is pared down to more normal levels, fiscal and monetary policy can do little to return the economy to previous growth rates. It is therefore misguided to blame the lack of growth on uncertainty about excessive regulation, tax policy and health care. It’s all about the debt.No matter what we do about regulation, taxes or health care, consumer spending will necessarily remain under pressure. Corporations are not hiring because they know that consumers are unable to absorb any additional products and services. Consumers are not borrowing since they want to reduce debt, not increase it further. Banks are reluctant to lend since they have mortgage debt on their books representing millions of homes that are underwater.
Household debt as a percentage of disposable personal income has averaged about 75% since 1952. It moved above that level in the mid-1980s and kept going until it reached as high as 130% at the peak of the housing boom. It has since declined back to about 114%, still far above any level prior to 2005. Even getting back to the 1987 level of 75% would restrain consumer spending for many years to come.
It has taken massive fiscal and monetary stimulus to engender the weak economic recovery experienced in the nearly two years since July 2009. We have seen TARP, the early 2009 stimulus act, cash for clunkers, tax rebates for first-time home buyers, near-zero interest rates, QE1, QE2 and other programs too numerous to mention. Despite these policies, the recovery has been the weakest of the post-war period and now shows signs of petering out with no new growth catalyst in sight.
At this crucial time the fiscal and monetary authorities are out of ammunition. They have taken their best shot, and it hasn’t really worked although they did prevent a collapse of the global financial system—at least so far. On the fiscal side the Federal government has run up a deficit dangerously close to 10% of GDP, and all of the acrimony in Washington is about how we cut it. Since increasing the deficit at this point is out of the question, the economy can expect no help here in terms of increasing the rate of growth.
The same is true of monetary policy as well. Chairman Bernanke has instituted virtually all of the extraordinary measures he outlined in his famous 2002 “helicopter” speech, and now there is nowhere to go. Interest rates, already near zero for the last few years, cannot go any lower while QE! and QE2 have ballooned the Fed’s balance sheet from $780 billion in late 2007 to $2.8 trillion by the time quantitative easing ends in a few weeks. The bar for starting a QE3 seems exceedingly high, and even then its chances for success are thin.
All in all we think that these policies are likely to fail just as they did in Japan since 1989. Over the last two decades Japan has undergone five recessions and GDP growth has averaged 1% annually. In light of this outlook we believe that stocks are highly overvalued and that investors are only beginning to become concerned. The S&P 500 closed today at a level below its January 14th close and has broken some significant support areas, indicating that an important downtrend may have already begun.
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