Wednesday, February 29, 2012

False Starts

This recovery has taken us on several emotional ups and downs. After a truly horrifying 2008-09, when the financial crisis and plunging real economic activity threw the US economy into the deepest recession since the 1930s, there were glimmers of optimism in 2010. But that proved to be a false start, and by late 2010 the economy was doing little better than during the darkest days of the recession. Again in early 2011 things seemed to be getting decidedly better... only to turn worse again and remain pretty lousy through most of last year.

But over the past couple of months we have now been experiencing a third round of positive signs on the recovery in the US. Is this spring likely to reveal yet another false start for the US economy?

I don't think so. I think this time the improvements are for real, and more sustainable. There are two primary reasons that I say this (putting aside the obvious one, which is "third time's the charm"). First, the housing market finally appears to be well and truly near its cyclical bottom. Yes, house price indexes are still showing some declines, but there is good reason to think that there's very little further for house prices to fall. House price-to-rent ratios and real housing prices are just about where they were in the late 1990s, before the housing bubble was even a glimmer in any home-owner's eye. It's not likely that prices will fall much further. And construction activity has already bottomed out, with changes in real estate construction now adding to economic growth rather than subtracting from it.

The second reason is that the process of debt deleveraging by American households is further along than it was during the false economic starts of 2010 and 2011.

Note: debt figures are from the Fed's Flow of Funds data; figures for 2011 Q4 are forecast.

This debt overhang has been a stubborn impediment to consistent growth in spending activity -- US households have been quite busy paying down the debts they racked up during the 2000s -- but over the past couple of years it has been eroded to a significant degree. This will make it easier for any gains in income to be translated into sustainable increases in spending, supporting the recovery in a way that didn't happen a year or two ago.

No one sensible is likely to be carried away by their excitement about this recovery. It will probably continue to be frustratingly slow in many ways, particularly with the relatively slow pace of job growth. But I do think that the recovery is likely to at least remain a real recovery through the rest of this year, which will be a welcome change from the past few years.