From GDP to Jobs to Trade and Fear, Full Economic Recovery Could Take Years

What we have come to call the Great Recession represents a hole in the American economy on the scale of the Grand Canyon—and we are nowhere near assembling a good enough footbridge across it. Let's first take a survey of what confronts us.

The gap between what the economy is producing now and what it would produce at full capacity is reckoned at 10 percent, the highest since the Great Depression. In the past two quarters, we have had the sharpest decline in gross domestic product since the end of World War II. The gap may not be closed until the middle of the next decade, making it likely that this recession will be not only the most severe but the longest since the end of WWII. At least $25 trillion of national wealth has vanished.

If we look at the geology of the big fault, we see the dynamic effects of the real and perceived loss of wealth: the plunge in house prices; the revival of the habit of saving, with consequent cutbacks in consumer spending and investment; the collapse of the stock market, which affects everyone sooner or later; and the rapid rise in unemployment.

Take housing. The value of the most important asset on the balance sheet of the average family—the home that 67 percent of American households own—has declined by an average of just under 30 percent. And there are still outstanding risks. If home prices were to fall another 20 percent, the average mortgage debtor would have lost all of the remaining equity in his or her home, producing more abandoned houses and foreclosures and undermining what is left of the market. Housing starts have fallen about 75 percent, down to about 460,000 units this year from the peak of 1.8 million units several years ago.

Take savings. Americans just a couple of years ago were saving virtually nothing from their incomes because they thought the rising values of their homes and financial assets provided adequate security. They have now increased their savings from zero percent to over 4 percent of disposable income. Since every dollar of savings means a dollar not spent on consumption, these savings represent a reduction of at least $420 billion of consumer spending. Furthermore, the savings rate is expected to rise to at least 8 percent, which would be consistent with the historical average for the current level of household wealth—and some polls indicate it might rise much higher as consumers conclude they need to rebuild their net worth, especially those who are close to retirement and need to replenish their retirement savings.

The natural effect of shocks to financial security inspiring the safety-first impulse to save and reduce debt will play out in even more downward pressure on business activity. We still have too much output capacity, too much overhead, and too many assets earning inadequate returns to spark substantial new expenditures on investment. In the first quarter, capital spending plummeted by a 38 percent annual rate. This overhang of excess capacity will further underscore labor capacity excess and continue to weaken wage growth, hence holding back consumer spending. The consequences are therefore bleakly negative not just for retail but for capital investment and hiring and may go on for a couple of years. Industrial production is already down 12.8 percent from a year ago, and capacity utilization is down to 69.3 percent—the lowest since records began in 1967.

Job drain. It is not really surprising in these circumstances that jobs have been shed at a faster pace than at any other time in the past 50 years. Instead of creating the 125,000 jobs each month we need to deal with new entries into the labor force, we are now losing more than 600,000 jobs a month. The financial sector, which had grown into a more central part of our economy, is now a major nega-tive, since each financial job lost causes three nonfinancial jobs to be cut—a record multiplier. The unemployment rate is estimated to peak at around 11 percent. The workweek is at a record low of 33.2 hours. The broader measure of unemployment that includes people who are working part time because they can't land a full-time job has risen to a fresh peak of 15.8 percent, making 24.7 million people effectively unemployed. The long-held notion that unemployment is a lagging indicator has been eroded; indeed, in these unusual circumstances it could very well be a coincident or even a leading indicator.