Monday, January 19, 2009

How Long will the Recession Last? How Deep?

I have serious doubts that an expensive stimulus package will do anything, but extend the pain of the current recession out for years.  We are currently paying the price for the last 10-20 years of consumer excess.  The U.S. consumer has been steadily reducing their savings rate in aggregate for a long time to the point of it going below zero percent.  The long term average savings rate for U.S. Consumers is 8% which is low compared to worldwide standards.  My take is that the savings rate will need to get back up to around 10% for a while before the economy can naturally bottom out.  Any stimulus that would encourage consumers to spend and not save just delays the point in time when the savings rate will increase to 10%.  It would also be nice if the Local, State and Federal Governments could live within their means, but I am not going to hold my breath on that one.  So the question is how much does the U.S. Economy need to contract before we hit bottom.  My guess is 10-12% based on the following logic.  Consumer spending accounts for about 70% of the economy.  In the most recent quarter, U.S. consumers have increased their savings rate to 2.8% and the economy has contracted by about 3% Year over year.  To get to a 10% savings rate it looks like the economy will need to contract at least 10%.  It’s tough to save in a recession, and to overcome negative savings rates in the past, the consumer will need to over save for a while as well.  That’s why I would guess a 12% contraction in the U.S. Economy is required.  So if we let the economy naturally contract by 3% a year for about 3 more years we should hit bottom.

Recessions serve a purpose and this is one of them.  Bringing companies and individuals back to economic reality.  However, if we decide to “stimulate” the economy to prevent this from happening, it will just delay the pain.  Let’s say that a stimulus package could half the current rate of economic decline to -1.5% per year.  Then it would take 6 years of decline to get the economy to bottom out.  When consumers start saving more it hurts the economy, but the spending rates have been unsustainable for a long time.  Trying to sustain those spending rates is a huge mistake.  Unfortunately, the right thing to do now is to encourage savings.  This will actually help out the banking system as well.  The banks will be able to recapitalize themselves by taking in more savings than they lend out to consumers.

The credit markets being frozen is a huge lie.  Does your credit card still work?  Mine did last time I checked.  Do you think someone with good credit, and a good job would be turned down for credit at Home Depot, Best Buy, or a car dealership? Think again.  Credit is only frozen to those who are not worthy.  Those who should be saving should not be borrowing.  Denying these people credit is a good thing, because if we can’t force them to save, at least we can force them to spend less.  Forcing banks to lend money is what caused the housing bubble.  Banks will continue to lend where it makes sense to do so.  They will continue to lend to people who can pay back the loan no matter how bad things get in the economy.

It would be hugely irresponsible for the government, who is incapable of paying their own bills, to borrow a ton of money to encourage others to spend.  Not only will it just delay the pain of the current recession, it will make it even harder to recover from it, because the consumers (i.e. U.S Tax Payers) will be stuck not only paying the price for their own excess, but will then have to pay the price for the government’s excess.  This could further extend this recession out unnecessarily.  Let’s all just step up and live within our means for a while.  We have been living above our means for way to long, and this is the only way to resolve our problems.  Propping up an economy that simply must contract will never work.

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At 11:28 AM, Blogger Instant Tragedy said...

Would you think a "New" New deal, with job creation to help build up a struggling and crumbling infrastructure would be a wise investment for the new administration?

I'd love to hear your thoughts...



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