Tuesday, July 15, 2014

Five Years of Chuggin' Along by Guest Blogger Buck Klemkosky

Buck was a finance professor at the Kelley School and the founding dean of SKK Graduate School of Business in Seoul. He is now affiliated with Wallington Asset Management. see http://wallingtonasset.com/robertklemkosky.html

The U.S. has experienced 11 recessions since the end of WWII and the most recent one has been the most severe. The Great Recession started in December 2007 and ended in June 2009 as determined by the National Bureau of Economic Research, an independent group of economists that has officially called the beginning and end of business cycles since the 1920s. So June 2014 marks the fifth anniversary of the end of the Great Recession.

What is the prognosis of the economic recovery thus far? Not good. It has been the slowest recovery in terms of economic growth than any other; it’s been more like a long, slow slog with growth averaging 2 percent annually over the 20 quarters. The first quarter of 2011 and 2014 even experienced negative growth although the latter may be due somewhat to the harsh winter. Economic growth in normal recoveries averages 4 to 5 percent annually. U.S. gross domestic product (GDP), the final value of all goods and services produced, did not recover from the 2007 peak until the third quarter of 2011 and it wasn’t until the second quarter of 2013 that GDP per capita surpassed the earlier peak. This is because there are 15 million more working-age people in the U.S. today than in the pre-financial crisis era. So technically, the economy has passed from recovery to an expansionary phase.

Why the slow recovery? Unlike the other 10 recessions since WWII, the Great Recession was caused by a financial crisis which in turn was caused by too much household debt (mostly mortgage) and an overleveraged financial system. Basically the U.S. experienced a credit bubble which imploded and caused the Great Recession. Evidence by Reinhart and Rogoff in This Time It’s Different: 800 Years of Financial Crises shows that recoveries from recessions caused by a financial crisis are weaker and take longer than from the normal cyclical recession. Debt has to be pared down and balance sheets strengthened before a return to normal growth. So the pace and length of the recovery was predictable.

Deleveraging since the Great Recession has occurred in households, mostly in the form of less mortgage debt, which fell from 73 percent of GDP in 2008 to 55 percent today. U.S. financial sector debt fell from 118 percent of GDP in 2008 to 82 percent today. Conversely, the federal government has levered up with debt rising from 72 percent of GDP in 2008 to 102 percent today. The government debt includes public as well as debt held by government agencies such as Social Security. The debt of non-financial corporations and state and local governments and consumer credit has been relatively stable relative to GDP, so overall the total U.S. debt-to-GDP ratio has fallen from 409 percent of GDP in 2008 to 392 percent today.

So what does the five-year recovery mean for American households? On average it has made them wealthier than ever. The aggregate wealth of U.S. households, including stocks, bonds, cash, real estate and other assets, hit an all-time high of $81.8 trillion in the first quarter of 2014, up $26 trillion since the low point in 2009. Most of this has been due to the stock market, where the S&P 500 has risen nearly 200 percent from its low of 667 in March 2009 to an all-time high recently of 1963. Housing prices have also rebounded; after falling 33 percent from 2007 to 2010, prices have rebounded 19 percent, still leaving house prices 20 percent below their peak.

So for owners of stocks, bonds and homes, balance sheets have been repaired and some households are now wealthier. The burden of household debt also has fallen as the debt-service cost (principal and interest) has fallen from more than 13 percent of after-tax disposal income to below 10 percent today. However, about half of American households do not own stocks and more than one-third don’t own homes. For many it doesn’t’ feel like a recovery has occurred.

While household wealth has more than recovered, the news for jobs and income hasn’t been as rosy. A key milestone was reached in May 2014 when U.S. payrolls surpassed the peak number employed in 2008. In other words, more jobs have been created in the recovery than lost during the recession. It took two years to wipe out 8.7 million American jobs, but more than four years to recover than all, making this the longest job recovery of any recession since WWII. Even though the unemployment rate has fallen from 10 percent in 2010 to 6.3 percent in May 2014, a look behind the jobs numbers shows that many of the jobs recovered are not necessarily the same ones lost. For example, over 3 million net jobs have been added in the healthcare, hospitality and food service areas, while over 3 million jobs have been lost in construction and manufacturing. The former are low-paying jobs and the latter higher paying jobs. 

Almost another 1 million higher-paying jobs in finance and government have been lost, and many of the new jobs created have been part-time. Also, the long-term joblessness rate is stubbornly and historically high at over a third of the unemployed. And the jobs recovery changes by region as energy states like North Dakota and Texas have done well and housing bubble states like Nevada and Arizona not so well.

While the jobs recovery has lagged normal recoveries, as expected wages also remain subdued; they have increased at about the same rate as economic growth. One constraint on wage growth has been slow growth in labor productivity, which has increased at about 1 percent annually in recent years. Even the middle class is feeling the pinch; median household income has fallen from a peak of $56,080 to $51,017 in 2013. Although improved since the recession years, subdued wages and less job security don’t bode well for consumer confidence, and why many don’t feel like an economic recovery has occurred.

Where does the economy go from here? Hopefully, because the economic recovery has been so weak, the economic expansion will prove to be more resilient than typical. At 60 months, this economic recovery and expansion is already the sixth longest since WWII. Another 13 months and it will match the 2001-2007 expansion, which included the housing boom. It has a long way to go to match the 1991-2001 tech expansion boom. But there are reasons to be optimistic: household budgets and balance sheets are in better shape, the financial system is stronger, Europe is coming out of its recession, fiscal and monetary policies are normalizing, inflation and inflationary expectations appear under control, and interest rates remain at historic lows. The best scenario is that the economy keeps on chuggin’ along but at a little better pace than the 2 percent average growth over the last five years. The economy needs more real income and wage growth to sustain the current economic expansion.


  1. That is a good explanation. The part about employment is accurate but I do not see where the jobs tat pay better will be created. I see a never ending trend to automate just about everything that formally employed medium paying jobs. Colleges are graduating people with degrees in things that have no employment future. In fact with less people in the age group to go to college than the boomer group, more high school grads are going to college but not finishing.

    The boomers cannot retire at the rate once projected because many have no savings. Others need to work at least part time to meet the higher cost of living (not recognized by the Government) associated with things they buy every day like food and fuel. So they are not leaving their positions unless those positions are engineered out.

    With lower wages or stagnate wages and less medium and high paying jobs incomes will stagnate and so will the main driver of the economy since the Romans....consumer spending. Taxes will have to be raised to compensate or the governments will have to do with less.

    I am not a doomsday person but I ask the questions: Where will the jobs come from? How will they be structure?

    1. James, the pace that Buck calls "chugging" reflects these demographic and labor trends and more. I cannot tell you where all the better jobs will come from but we have had time periods wherein machines replaced workers and the adjustments were not easy. But they were always followed by times of robust economic and employment growth. Policy needs to protect less and allow for economic change to unfold. Let companies adapt to what is new and I am confident that some of these problems will disappear. I doubt anyone could have predicted the future of manufacturing when agricultural workers were being replaced by tractors....I won't try to predict where we will go from here...

  2. Good explanation! It goes along nicely with Brian Wesbury's piece:http://www.ftportfolios.com/Commentary/EconomicResearch/2014/7/14/what-if-potential-is-just-1.5percent