A host of commentators are arguing that the current U.S. slowdown – the most severe in a quarter century – is far from over and in fact destined to get much worse. The argument usually invokes a parallel with the Japanese recession of 1990. In Japan in 1990, real estate prices fell sharply after rapid increases over the previous decade, the stock market fell dramatically, and most large banks became either insolvent or very short on capital – all similar to what the US has experienced. And Japan subsequently went through a great-depression style slowdown in economic growth from which they have still not fully recovered.
While there are parallels between the US in 2007-2008 and Japan at the start of the 1990’s, there are also such vast differences that it seems hard to believe that the Japanese case, or our Great Depression of the 1930’s, are reasonable analogies for the current outlook. While one cannot know the future, let me provide three short comments on the main differences.
First, the initial declines in macroeconomic indicators are more consistent with the 1982-1983 U.S. recession than with either early-1990’s Japan or the U.S. great depression. To jog your memory, the unemployment rate peaked at 10.2 percent 16 months into the 1982 recession, and the current rate is “only” 8.9 percent. Now the 1982 recession was only 16 months long, but our recent macroeconomic numbers are leading most economic forecasters to predict recovery by the end of this year. Thus, it seems reasonable to expect a similar peak in the unemployment rate in this recession, rather than the 25 percent of the great depression. I expect that many pessimistic reactions to the current recession come in part from how different our current decline is from the stable economic growth we had become accustomed to in recent times. Since the 1982 recession, we have had only two brief and (relatively) mild recessions and the longest peacetime expansion followed by the longest expansion ever recorded in the U.S.
How much of our previous stability was due to luck or policy is still to be completely understood, but the policy responses to the current crisis are consistent with the second reason that I think we are in a recession and not the start of a depression. The US has undertaken massive and coordinated fiscal and monetary stimulus measures, to the point where it is hard to tell where fiscal policy ends and monetary policy begins. This is a good thing for ending the recession, provided of course we are able to return to balanced-budget policies in the near future. The risks for a more serious slowdown come not from the recession do far or from current large deficits, but from other long-term fiscal imbalances that have been looming on the horizon for decades, primarily pension and health care deficits. These problems haunt budgets at the federal, state, local, and even firm levels (and the federal government acts as insurer to firm pension funds).
The final reason that the US is not headed for a Japanese-style decade of lost growth is that the US economy has better economic fundamentals. The Japanese model worked well for much of the post-War period, but the economic-political structure had trouble dealing with the large changes that growth and then recession required. The US has relatively flexible capital and labor markets, so that when we stop building houses, workers (and equipment) find other lines of business. A great example of the Japanese approach is given in this article in the New York Times. Most Japanese firms do not fire workers but instead move them around to do other jobs when their old jobs are not productive. The article describes a sheet metal company that, when demand fell, started using its factory and workers to grow “parsley, watercress and other plants . . . staff tend the sprouts religiously, topping up the water supply, adding fertilizer and adjusting the fluorescent lights.” Is this the best use of these resources? Really? Might it not be better for these highly-skilled metalworkers to be out looking for other jobs and for this factory space to be for rent rather than being used as an indoor farm? To give some perspective, in the US from June to September 2008 (during the recession which began in December 2007), “the number of job gains from opening and expanding private sector establishments was 6.8 million, and the number of job losses from closing and contracting establishments was 7.8 million” (Source: Bureau of Labor Statistics). That is, during this recession, businesses have hired the equivalent of 4 percent of the labor force which, for comparison, is about the same percent as the increase in the unemployment rate during this recession. While unemployment is not good, the hiring is great. The risks for the US economy are not business as usual, but that in trying to end the unemployment, we eliminate the hiring. That is, our policies should not provide support capital and labor that should instead be finding employment elsewhere. At the moment, U.S. policies only have this flavor in the banking and automotive industries, and even in these industries there is significant elimination of jobs and the government is trying to get in and get out quickly. Thus, I expect that, while painful, we are in a recession not a depression.
In my opinion, this is a very poorly written article.
There are four fundamental areas we need to consider with respect to economic recovery:
1. unemployment level
2. stabilization of housing price and reduction of foreclosures
3. government deficit and debt level
4. clean-up of the banking sectors
The government has been consistently under report unemployment numbers. And for #2-#4 above, most indicators are showing that things are getting worse.
I think the author might be correct that we won’t get into a depression due to government’s massive bailout. However, drawing parallels to 1980 recession seems to be far fetched, since the causes of the current recession is very different comparing to the 1980 recession.
I actually agree with Andrew’s points three and four. The level of government debt, particularly projections of future revenues and liabilities, are a concern for long-term growth. Concerns of prospective deficits (or high taxes) could slow recovery and/or lead to low future growth. We also need to consider the state of the banking sector, actually the financial sector more generally. But when we do consider it, the answer is basically that things are returning to normal—no longer are high-quality “loans” to firms priced very differently than loans backed by the government—spreads have come almost back to normal levels —see the really striking graphs at
http://www.federalreserve.gov/releases/cp/
On points 1 and 2, the employment situation is an indicators or symptom rather than cause of the recession. And it is an indicator that the Bureau of Labor Statistics does a great job of measuring. The BLS now for example reports measures of how many workers are working part time because they cannot find full time work. And as to housing prices, given the amount they have fallen (although exaggerated by some indexes) and given that the financing of homes is back to normal (circa say 2000), house prices are also now more of a symptom of the economic situation than a cause of crisis.
Thanks for the feedback, Jonathan! Sorry I was a little bit too harsh on my previous comment!
A couple comments:
1) regarding the BLS numbers, correct me if I’m wrong, they don’t count “people who stopped looking for jobs” as unemployed, right? That might skew the number although I’m not sure how significant it’ll be.
2) regarding housing, I’d argue that the housing market is only temporarily “stablized”. And if you look into the detailed number, most house purchases are low-end homes, purchased by investors who want to use it as rental property, or first-time home buyers who want to take advantage of the low mortage program.
However, the percentage who are “upgrading” from small house to larger ones is very small.
Furthermore, in the past few weeks, US currency has gotten weaker. I think it’s because foreign countries are selling off US Treasury bonds they’re holding. I’m afraid that US government might not have enough money to hold the mortgage rate low. I hope I’m wrong, but it could get pretty ugly.
I think the article missed the problem. This is not a typical post WWI recession. Post WWII recessions were caused by tight monetary policy, which was used to reign in monetary inflation. In the mid 1990s, the situation changed. The US economy seemed less able to create real wealth (perhaps due to the flight of manufacturing overseas), and the Federal Reserve moved from a policy of curbing inflation to one of creating full employment. This produced the dot.com bubble of the late1990s and the real estate bubble of 2002-2006. We substituted debt for the creation of real wealth that could produce rising salaries for workers, There were endless stories of this new paradigm, workers running up credit card ebt,then “paying it off” by refinancing their houses at low rates. People taking public dot.coms that no real prospect of earnings and getting rich. People flipping properties to become real estate millionaires. It was great fun while it lasted, but it was a fool’s paradise, and now the bill has come due.
What we have now is a good old-fashioned 19th century credit panic with 21 century characteristics(globalized, securitized). Those 19th century panics (dont you love how well that word fits our current situation) were caused by over extensions of credit. Their recovery only occured when saving levels were rebuilt and bad loans written off. That process usually took 3-4 years.
The Great Depression was an extreme credit panic that wiped out the savings of a generation. It was finally cured not by the New Deal or even WWII spending, but by the combination of WWII spending and FORCED SAVINGS that rebuilt capital levels and enabled the post war recovery.
The Japanese financial crisis of the late 1980s was one of these credit recessions. it’s recovery took over a decade because Japan had huge savings to throw at the problem. This eased the pain but postponed the debt writeoffs which were part of the recovery process.
The Obama plan seems modeled after Japan, huge government spending combined with support of key companies. The only problem is that the USA does not have the stockpile of domestic savings that Japan had to pay for such a program. Instead we are borrowing the money from China, which is why Secretary Geithner spends more time in Beijing that Wall Street. The Chinese are shrewed capitalists, and I think they will be unwilling to fund year after year of record setting US deficits. So the ability ot the USA to postpone the day of reckoning will be much shorter that Japan’s.
If you look at the mortgage statistics, there are record amount of ARMs due to reset in 2011. That will create more pressure on the system. By then however, China is likely to have substantially reoriented its economy to grow by serving domestic consumption. It will be less willing to lend to the USA to pay for the stratospheric deficits the Obama administration is projecting.
The USA will then face the prospect of writing off bad debt combined with the much higher taxes required for the Obama agenda. That combination will severely inhibit private sector growth and result in a double dip recession.
Real recovery requires the rebuilding ot the lost saving and capital wasted in the bubble era. That will require a higher domestic savings rate, which is already occuring, and time to rebuild savings. During this period, credit will be relatively scarce, and industries dependent on it such as the auto industry will see several years of depressed sales. It may be that US auto sales will not hit their 16 million a year peak for a decade. That said, the overall recovery ( as defined by 6% unemployment) might start to become evident in 3-4 years, just like the 19th century panics this one so closely resembles.
Andrew, unemployment does not include discouraged workers, but the BLS does a pretty good job of measuring them: http://www.bls.gov/news.release/empsit.t12.htm. Adding discouraged workers to unemployed workers one gets a rate of 9.3 percent, up from 5.3 a year ago. As to house prices, see my new post.
RJ Dragon, I agree that this recession is not like the others. But none of the others have been like the others too: in 1973 we had an unprecedented oil price shock, in 1977 in 1982 we were fighting unprecedented inflation, in 1991 a credit crunch and so forth. And I do not see the Great Depression or the 19th century financial panics seem like poor analogies to me, primarily because of the differences in policy between then and today.
Well it is good to see there are a variety of opinions. Time will tell who is right. If recovery is rapid and unemployment is down to 6% by June 2010, then Jonathan’s faith in macroeconomic policy will be vindicated. If unemployment is over 7% in January 2011, then my view that the recovery will be slow will be right.
My position is that the capital lost in the bubble era will take years to rebuild. This will require a higher savings rate and consequently reduced consumption, which will lead to slower growth for the next 3-4 years. I agree with the Congressional Budget Office that the Obama Adminstration’s borrowing plans are unsustainable. So unless the recovery is very rapid, the possibility of a double dip recession or stagflation exists.
Post WWII recessions were generally caused by the Federal Reserve restricting monetary growth to fight inflation. Recovery ensued as soon as the Fed quit restricting monetary growth.
This recession, ilike 19th century financial panics, was caused by a credit collapse and the destruction of capital in asset bubbles. It will take years of increased savings to rebuild capital. Moreover the ability to borrow 100% of a house’s value will not likely return soon. We’ll see more loans with 20% down payments, and fewer and smaller home equity loans. That will impact consumption over the long-term.
What is comes down to is whether the USA will return to the late 1990s – early 2000s debt-fueled economy or whether there will be a permanent shift to a less leveraged economy. I am betting on the latter.
While I by no means claim to understand the economy, I do claim to be fairly well informed of the construction industry, housing and otherwise. What we have witnessed in the housing market (new construction) is reflective of the construction economy as a whole.
Since 1967 we have seen not a single decrease in material and labor prices. In fact, we have witnessed continuous increases for over 40 years. Until 2009.
If we review years 1967 through, say 2004, we see an extremely consistent rate of change in construction costs – R2=0.974 (and know that new homes, and to some extent how we “value” them, are a derivative of initial construction costs). In years 2004 through 2007, however, costs skyrocketed, averaging annual increases of 9.27 percent in those years. However, we are projecting construction costs to decrease in 2009 over 2008 by nearly 19 percent. Costs decreased by nearly 6 percent in the first quarter of 2009 alone.
This being said, those of us in the construciton community simply feel that this correction in the housing industry is due, or I should say, I feel it is due. In fact, assuming we are correct in our forecast of costs declining by nearly 19 percent in 2009, this places us squarely in line with where costs were in 2005. But the good news is that we see the construction economy beginning to recovery in 2010.
So as for the specific argument as to what we wish to call this rather pathetic economic situation, I will leave to others. However, for those us us in the construction community, we had it coming. And now we are paying for it!