U.S. Economy in Deepening Recession

By: Hans_Wagner

Does any Know Where the Economy is Going? - The U.S. economy has been in a recession for more than a year now. The current administration is now debating an additional stimulus package to help turn the economy around. Lead by followers of John Maynard Keynes, the father of deficit spending, the U.S. government is bent on spending its way out of the recession. Do these programs have a chance to help the economy recover and start a new long-term economic expansion?

This is the first of a three part series on the prospects for the economy. Without a road map, the current leaders of our economy are following the theory without any guideposts or road maps based on historical experience. They are taking a significant risk. First, we will look at the mess we are in. Then their answer followed by two other possible outcomes.

The Economy is in a Mess

The current recession is more than a year old. Some economists estimate the 4th quarter GDP will be down between 4 and 5%. 2009 looks like more of the same.

While there has been some improvement in the credit markets, a number of large banks are experiencing larger losses that calculated just a coupe of months ago. Citigroup is being forced to sell its brokerage unit Smith Barney to Morgan Stanley to help generate cash to cover additional losses. Bank of America is seeking additional TARP funding to help cover more losses from their acquisition of Merrill Lynch. John Thain, the former CEO of Merrill was fired recently. I suspect the expenditure of more than a million dollars to refurbish his office and bathroom did not help his cause. Such large losses have sharply curtailed any potential of new extensive lending activity that will help fuel a growing economy.

Unemployment is getting worse with the official rate set at 7.2%. More than 3 million people have lost their jobs in the last 12 months. Another 3 million are underemployed, meaning they are working either part time or at jobs just to pay some bills rather than using their skills. Think of financial analysts driving taxi-cabs, offering investment advice for free. This does not count the long term unemployed, those who have given up looking for work. The employment picture is bad and getting worse. I suspect we will see an unemployment rate nearing 10% before it finally starts to turn down.

Consumer spending is drying up, down 3% for 2008. With the employment picture so dim, we should expect the consumer to cut back on their spending even further in 2009. Those that do have some extra money are saving it. Remember the tax rebate stimulus package of 2008. About 85% of the people who received a stimulus check put it into savings, rather than spend it. Why will it be any different this time? The collapse of many people's retirement and investment accounts has reminded everyone that it is important to have a savings plan. Some analysts are forecasting a savings rate of 6% in a few years, up from a negative one only a couple of years ago.

Housing prices continue to fall as inventories of unsold homes close in on 12 months of supply. Gary Shiller has indicated that he believes home prices will fall another 15% before finally reaching equilibrium with the long-term true value of housing. Contributing to this problem is the number of foreclosures keeps rising. For those people who have had their mortgage adjusted to avoid foreclosure, about half of these revised mortgages have gone back into default after six months.

New home construction continues to fall as those that can afford to buy a house are waiting for better prices. As mentioned, there is a large supply of unsold homes on the market. I suspect there are a number of people who want to sell their homes, but are waiting for the market to stabilize. This means that as the inventory comes down new supply will be coming onto the market. It will take several years to work through this oversupply, hindering homebuilders' ability to ramp up construction of new homes.

Truck and auto sales have fallen from an annual rate of more than 16 million to a 10 million rate. Since cash from home refinancing supported many of the sales of vehicles, it is unlikely that this sales level will not return for quite a long time. This means that the entire industry must readjust their businesses to reflect a much lower sales level. Add in President Obama's goal of producing more autos that are electric and the industry is faced with a wrenching restructure of their entire business.

Global trade is falling with China now expected to see a drop in their GDP due to the plunge in exports. Governments around the world are considering what to do to help shore up their economies. Fortunately, the one thing that most of them have learned is that restricting trade will only make the recession worse. Let's hope that they don't forget this lesson as they struggle to fix their economies

Earnings from corporations continue to fall. Many companies are lowering their guidance even further as they expect sales to slow or even turn down during 2009. Many analysts see a bottoming of the earnings decline in the second half of 2009. These same analysts saw a bottoming of the earnings fall in the second half of 2008. This could be wishful thinking. If the economy remains in the doldrums, corporate earnings will not recover.

There is some positive news. Interest rates are very low with short-term rates just above zero. Even the 10-tear rate is at a low level, which those with adjustable rate mortgages. The Fed was able to get these rtes low enough to avoid another big credit problem as many adjustable rate mortgages are set to reset their rates over the next two years. Now those rates will be lower than many expected. In addition, some people have been able to refinance their mortgages, since they have the income to support proper lending criteria.

Probably the best stimulus has already taken place. The price of oil has fallen from a high of $147 to the $40s. This directly helps consumers and business putting more money into their pockets than any mentioned stimulus package. Yet it has done little to overcome the current recession. This is a sign that any stimulus package might not achieve the desired goal.

The U.S. economy is a mess, probably the worse since the Great Depression. Correcting all of these problems will take time. Moreover, we do not have tangible experience that any of the proposed initiatives will work. One thing we do know is that the current administration is using Keynesian deficit spending theory to right the ship. We are in for a rough ride ahead. Next week we will look more deeply into the Shock and Awe program contemplated by the Obama economists and the Democrats.

By Hans Wagner
tradingonlinemarkets.com

My Name is Hans Wagner and as a long time investor, I was fortunate to retire at 55. I believe you can employ simple investment principles to find and evaluate companies before committing one's hard earned money. Recently, after my children and their friends graduated from college, I found my self helping them to learn about the stock market and investing in stocks. As a result I created a website that provides a growing set of information on many investing topics along with sample portfolios that consistently beat the market at http://www.tradingonlinemarkets.com/

Copyright © 2009 Hans Wagner

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