June 2012 marked the third anniversary of the end of the Great Recession. Conventional wisdom is that the strength of an economic recovery is related to the depth of the recession; deeper recessions lead to stronger recoveries.
That wisdom has certainly not proven prophetic three years into the current U.S. economic recovery as growth in real (inflation adjusted) Gross Domestic Product (GDP) has been 2.4 percent since July, 2009, the start of the recovery. This is about one-half of what real GDP growth would normally be three years into an economic recovery and lags the longer-term (1997-2007) U.S. GDP growth rate of 3.4 percent.
Growth in employment, albeit slow, appears to be faring better than GDP growth as the unemployment rate has dropped from a peak of 10.1 percent to 8.2 percent today. However, those statistics are misleading. During the Great Recession, 8.8 million jobs were lost while only 4.5 million jobs have been created so far during the recovery. Thus, there are fewer jobs in the U.S. today than in December 2007 when the recession started. In spite of fewer jobs, the unemployment rate dropped because of the decline in the civilian labor participation rate. This rate measures the number of people (16 years of age and older) who are working or looking for work versus the number of people in the total population.
While the potential number of workers has increased during the recovery, the number of workers leaving the workforce has increased even more. As a result, the labor participation rate dropped from a peak of 67.3 percent in 2000, to 65.7 percent when the recession ended, to the current rate of 63.8 percent, the lowest level since 1981-82. A continued decline is unusual in an economic recovery because more people, not less, usually seek employment as the economy improves.
So where have all the workers gone? Some of the baby boomers (those born between 1946 and 1964) may be retiring early, marginal workers (those who worked less than 6 months the previous year) may not have entered the workforce because of slow job growth and stagnant wages, and more potential workers are opting for government subsidies. Medicaid spending, disability payments and food stamp usage have all risen sharply in recent years. The reality is that no one truly has a good grasp of the numbers and exactly why people are leaving the workforce.
There are multiple reasons why the U.S. economic recovery continues at a below average pace. First, the Great Recession was caused by the severe financial crisis of 2007-2008. Households have been forced to pay down debt (deleverage), and banks have had to increase their capital base by extending less credit. Evidence shows that recoveries from financial-caused recessions are slower than from other recessions because of the deleveraging that has to occur. This deleveraging process will take more time to work its way through the system, so expectations are that slow economic growth in the U.S. will likely be the norm at least for the next few years.
As the experience of Japan has demonstrated, asset bubbles such as in housing can impede an economic recovery. U.S. home prices have fallen about one-third from their 2006 peak because of the speculative bubble in housing prices and the over-supply of houses. Usually construction, housing and commercial, leads an economy out of a recession, but that is not occurring this time. Construction jobs in the U.S. are still nearly 30 percent below their peak. Until housing prices stabilize and the excess capacity is worked down, this important segment will continue to be a drag on the economy.
The U.S. corporate sector is sitting on nearly $1.7 trillion in cash and cash equivalents and they are investing less in plant and equipment than normal in an economic recovery. This reluctance to invest has been due to problems in the Eurozone, a slowdown in China, regulatory reform, healthcare costs (including the Patient Protection and Affordable Care Act), the so-called fiscal cliff facing the U.S. in 2013 when the Bush tax cuts expire and mandatory spending cuts to the U.S. budget take place, and escalating public-sector debt. Corporations' hesitancy to invest coupled with gains in productivity are the primary reasons why the number of manufacturing jobs in the U.S. is still more than 15 percent below its 2007 peak.
What can be done to stimulate the U.S. economy to a faster pace of growth is an important issue facing policymakers and investors today. Monetary policy has essentially played out with historically low interest rates, several rounds of quantitative easing, excessive bank reserves, and massive amounts of liquidity. There also continue to be strong political headwinds against further stimulation as the effectiveness of Chairman Bernanke's aggressive stance toward monetary policy in response to the Great Recession has been called into question many times.
Fiscal policy is constrained as the U.S. has already borrowed more than $5 trillion to cover fiscal deficits since the start of the Great Recession. Some may argue that there has not been enough stimulus, but $5 trillion has resulted in GDP growth of less than $1 trillion. The bond markets are closely monitoring public-sector debt and will quickly raise bond yields if government debt and deficits appear unreasonable.
What the U.S. economy may need more than anything is confidence. Confidence that government can control spending and deficits, that consumers can spend and in the process not take on too much debt, that banks can provide credit again but also manage risk, and that regulatory reform is reasonable and not anti-business. Otherwise, it is difficult to see what will get the U.S. economy back to a normal growth rate and off its present path. With such tepid growth, the economy is more susceptible than otherwise to falling into another recession and not making it to a fourth anniversary.
Time will tell, but it would certainly help for the leaders of this country to put their partisanship aside to come up with creative solutions to bring confidence back into the economy. In so doing, the U.S. would once again prove its resiliency as it has done so many times in our history and allow our country to have one of the highest standards of living in the world. Also, we all need to keep the slow growth recovery in perspective. While there are countries such as China and India which are growing faster, the U.S. economy does not appear all that bad when considering many economies across the globe. No doubt this is one of the major reasons behind the out-performance of the U.S. stock market recently compared to most international markets. This is in spite of many U.S. investors leaving equities altogether the past couple of years after two severe bear markets since early 2000.
However, as BCA Research recently alluded to in their research report entitled "Nearing The End of The Secular Bear Market in Equities?", many of the characteristics of the financial markets today suggest we are much closer to the end of the secular bear market in equities than the beginning just as we are much closer to the end of a secular bull market in bonds than the beginning. This is not to suggest that the investing climate will get any easier in the near term as secular transition periods can be volatile and take time to pass. They often serve to seriously test the fortitude of investors. Just as with the economy, an increased dose of confidence would certainly help investors maintain the discipline necessary to be successful, long-term, in the financial markets; particularly if volatility increases as BCA Research suggests; particularly if equity prices grow at a pace that does not match their recovery from the bear market of 2007-2009 or, for those who have a longer memory, the pace of the roaring decade of the 1990s.
Ronald Reagan said, "There are no great limits to growth because there are no limits of human intelligence, imagination, and wonder."
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