US Economy Expected to Grow Only 1.5% Per Year For The Next Decade

   It seems that Ben Bernanke and fellow central bankers had a sobering moment during their annual Jackson Hole retreat. One of the papers presented at the meeting was titled "After the Fall," by Carmen and Vincent Reinhart. The paper studied previous financial crises and country specific shocks including the 1929 stock market crash, the 1973 oil shock, the 2007 U.S. sub prime collapse and fifteen severe post-World War II financial crises to determine how economies recovered over a 10 year period following the event. The results were not encouraging and portend a similarly grim fate for the US and European economies: low GDP growth, high unemployment, and declining home prices. It will feel pretty much like a perpetual recession for the real economy.  Here are the main conclusions from the paper:
1. On GDP Growth

Real per capita GDP growth rates are significantly lower during the decade following severe financial crises and the synchronous world-wide shocks. The median post-financial crisis GDP growth decline in advanced economies is about 1 percent.

2. On Unemployment

In the ten-year window following severe financial crises, unemployment rates are significantly higher than in the decade that preceded the crisis. The rise in unemployment is most marked for the five advanced economies, where the median unemployment rate is about 5 percentage points higher. In ten of the fifteen post-crisis episodes, unemployment has never fallen back to its pre-crisis level, not in the decade that followed nor through end-2009.

3. On Home Prices

Real housing prices for the full period is available for ten of the fifteen financial crisis episodes. For this group, over an eleven-year period (encompassing the crisis year and the decade that followed), about 90 percent of the observations show real house prices below their level the year before the crisis. Median housing prices are 15 to 20 percent lower in this eleven-year window, with cumulative declines as large as 55percent.

4. On Deleveraging

In the decade prior to a crisis, domestic credit/GDP climbs about 38 percent and external indebtedness soars. 5 Credit/GDP declines by an amount comparable to the surge (38 percent) after the crisis. However, deleveraging is often delayed and is a lengthy process lasting about seven years. The decade that preceded the onset of the 2007 crisis fits the historic pattern. If deleveraging of private debt follows the tracks of revious crises as well, credit restraint will damp employment and growth for some time to come.

5. Policy Reflections

The human temptation to credit good fortune to good character and bad results to bad luck further complicates matters. A ubiquitous pattern in policy pitfalls has been to assume negative shocks are temporary, when these were, in fact, subsequently revealed to be permanent (or, at least, very persistent).

   The only question is if Ben Bernanke and the Fed can prevent these outcomes in the US. Is money printing the solution to a damaged economy? Or are we going to end up like Japan, where QE did nothing for the economy or asset prices long term. The bond market obviously believes the latter with the 10 year at 2.5%. According to the study the only positive outcome of financial crises is that inflation often falls and remains low for an extended period of time.

    In my opinion the most disturbing conclusion from the study is the common mistake by policymakers in assuming the economy will quickly rebound. This error often leads to short-term policy actions and fails to solve the real problems facing the economy. In the case of the US the main problem is an insolvent banking system, which refuses to lend money to the real economy. The US government has refused to tackle this problem. Their "solution" was to prop up failed banks with taxpayer money. While this has temporarily stabilized the banking system it has not solved the problem. This short term thinking only prolongs the process of deleveraging within the banking system as insolvent institutions desperately try to earn their way out. Total bank credit will continue to contract, which will further reduce investment and capital spending. The study found that deleveraging usually takes 7 years, but we may be facing a longer road thanks to government inaction. Insolvent banks with government guarantees are still holding onto bad debts (mainly mortgages) in the hopes that they will eventually recover. What is needed is strong action by government (not likely) to force banks to once and for all purge themselves of their bad debts. The banks need to take the hit and raise more capital. Once the banking system is recapitalized and free of bad debts, credit growth will resume and provide conditions necessary for a real economic recovery. Until then, we are looking more and more like Japan--destined for prolonged stagnation.

Related articles:

Financial Globalization Has Rendered The System Increasingly Susceptible To Collapse

US Economic Outlook--3 Possible Scenarios


Black Swan Insights

US Economy Expected to Grow Only 1.5% Per Year For The Next Decade