Why Recovery Might Be Slow

Economic recovery seems to be underway. Still, with consumer spending the key to economic activity (70% of GDP), news that retail sales (consumer buying) unexpectedly dropped, along with the University of Michigan index of consumer confidence, plucks out a sour note of caution. Consumers have a hard time feeling positive with unemployment still rising and annual housing price levels still sinking.

Nouriel Roubini, a professor at New York University’s business school, predicted in 2005 that a once-in-a-lifetime housing bust would trigger a deep U.S. recession. So we should listen up when Roubini today tells us:

➢ during post-war recessions, average monthly job losses ranged between 150,000 and 260,000. Average monthly losses in this recession are still at 350,000. For the labor market to stabilize, job losses need to slow to 100,000 to 150,000 per month.

➢ the economy has lost over 6.6 million jobs since the recession began; in previous recessions job losses only ranged between 1.5 million and 2.5 million.

➢ companies are reducing compensation and work hours to keep a lid on labor costs. Private sector labor compensation slowed to 1.5% in the 12 months ending June 2009, the smallest increase on record.

➢ Average weekly hours in the private sector, despite slightly improving in July 2009, are still hovering at record-low levels. Company efforts to maintain profit margins through lower pay will backfire in the form of subdued sales as labor incomes suffer.

➢ 53% of the unemployed have been jobless for over three months and 34% of them for over six months, the highest share on record. Over 50% of the unemployed have lost their jobs permanently, again the highest on record.

➢ inadequate safety nets, the dearth of labor retraining programs and tight access to student loans suggest that when workers begin looking for work during the recovery, they will face skill mismatches helping raise structural unemployment from below 5% in 2007 to close to 7%.

➢ consumer credit has been contracting since Q4 2008, and mortgage equity withdrawal is negative as home prices have about 10% more to fall.

➢ investment recovery will lag consumption recovery. With sluggish consumer spending and rampant excess capacity in the economy (capacity utilization is at a record low of 68% compared to the historical average of 81%), firms will be reluctant to invest in structures and equipment. It may take years for capacity utilization to return to pre-recession levels.

➢ the inventory-to-sales ratio hasn't come down significantly (the ratio is still over 1.40, while the historical average ratio is close to 1.25). This is because sales are plunging faster than inventory drawdown.

➢ in short, the economy might sink into lower growth sometime in 2010, because the U.S. consumer is still pulling back.