A Quick Recovery? Keep Dreaming

Boy, were people happy two weeks ago, when a 30%+ stock rocket ride from the bottom convinced everyone that we were headed for a spectacular economic recovery. 

Spirits have dampened somewhat since, with the market going limp day after day.  But stocks are still hanging around fair value, and a sense of optimism remains.

Well, regardless of what the market does over the coming weeks, don't embrace the happy talk that we're going to suddenly go right back to life as it was in 2007. 

The key problem in the economy, remember, is debt--specifically, way too much of it.  See the chart from the SF Fed above, which compares debt, wealth, and income. The good news is that consumers have finally started deleveraging.  But their wealth has plummeted a lot faster than their debt. And if history is any guide, the deleveraging process is going to take decades, not years.

Take a look at that chart of Japan's experience below, from the San Fran Fed.  Look at where they are now compared to where we are now (the series aren't apples to apples, but the deleveraging process is similar).  Note that Japan's economy is in the middle of its second decade of stagnation.  And its stock market is trading at one-fifth of its pre-deleveraging peak.  (The analogous performance for us would be DOW 3500 in 2026).

In future years, US consumers will have to save money to pay down all that debt.  The savings rate will likely go back to its level in the good old days--8%-10% of GDP (see chart below).

All the money consumers devote to debt reduction, meanwhile, will be money that they aren't spending.  If our situation is similar to Japan's, the SF Fed estimates--if we go back to our pre-binge leverage ratios--this consumer deleveraging will shave 3/4 of a percentage point per year in consumption growth. (About half a point of GDP growth).

That doesn't sound like much?  Many future economic forecasts, and many stock-market forecasts, are based on long-term growth of 3%+ per year.  (The forecasts underlying Social Security and Medicare, for example.)  Cut the growth of consumption by 75%, and you're also going to have businesses investing less.  Add it all together, and you're probably shaving a point off GDP growth, so that the long-term growth rate might be 2%, not 3%.  That makes a big difference for tax revenue (not to mention Social Security contributions).

The SF Fed's report is here.  Zero Hedge has more thinking on this >