Why the Economic Recovery Might Be Real This Time

Cowed consumers are finally starting to feel upbeat.

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We've seen this movie before, right? It begins with signs of an improving economy, but the plot reversal happens as oil and gas prices surge, Europe implodes, Washington threatens reckless policies, or some other shock chokes off the nascent recovery.

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That's what happened in 2010 and 2011, so it makes sense that something similar could happen this year. Even though unemployment is falling, the stock market is buoyant and consumer confidence is growing, there's still plenty that could go wrong. Greece could violate its bailout terms and completely collapse. A war in Iran could send oil prices skyrocketing. Congress could flub some big decisions due by the end of the year on taxes and spending.

Yet the economy seems to be showing unusual moxie, shrugging off most of those concerns and doing better than expected. At the beginning of the year, many economists expected lackluster growth of less than 2 percent in 2012. Those forecasts are steadily being revised upward, with more room to rise. "For all of the weakness that is expected to play out through 2013," economist Jeffrey Rosen of Briefing Research recently predicted, "we see more upside potential than downside risk."

So is this one more bubble that's about to pop? Or a long-overdue updraft that's likely to continue? Economists aren't sure, needless to say, but the evidence of a lasting recovery is much stronger than it was last year or the year before. Here are four reasons that this time, the recovery might be real:

Time has passed. The recession that began at the end of 2007 officially ended in the middle of 2009—nearly three years ago. Yet the lackluster performance of the economy since then makes many people feel like we're still in a recession. Over that time, however, economic wounds have slowly been healing, and sooner or later that will produce an economy that's actually healthy.

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Banks, for one thing, have been gradually disgorging bad loans and improving their once-precarious financial positions. Bank of America Merrill Lynch estimates, for example, that the financial sector has cut its debt load by a hefty $3.5 trillion since 2009. Some banks still have further to go, but credit standards generally are loosening, which is vital for a true recovery.

Consumers have been paying off debt as well, and improving their finances. One recent survey found that the percentage of employees saying they're under severe financial stress fell from 33 percent in 2009 to 19 percent in 2011. Painful declines in home prices, meanwhile, may now be close to a bottom. And companies that have cut every imaginable cost can scarcely afford to lay off one additional worker. Those developments don't characterize a robust economy, but they set the stage for it.

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Debt burdens have fallen dramatically. The dollar value of household debt held by Americans is still uncomfortably high. But low interest rates, largely engineered by the Federal Reserve, have sharply reduced the "debt burden" many consumers feel, in terms of the amount of income it takes to make payments on their debt every month. Many new mortgages and car loans have come at record low interest rates, and some consumers have been able to refinance old debts at much lower rates. "Even though Americans have a lot of debt by historical standards, they have a low debt burden," says Rosen.

By one measure, the amount of disposable income available to the typical consumer is at the same level as in the mid-1990s, when the economy was in the early stages of a boom. That doesn't mean that gun-shy consumers will spend every last dollar they have. But it does mean that restraints on spending are loosening up, and just as important, that consumers have less reason to feel panicky.

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Stuff is cheap. A combination of low interest rates and falling home prices has made housing more affordable than at any time over the last 40 years. Cars and other high-ticket purchases that often require financing are relatively cheap too, thanks to low interest rates. And improving credit standards are giving more people—including subprime borrowers—access to loans. As confidence improves, more consumers will take advantage of these terrific deals and start spending, which will help generate other kinds of economic activity and bring back jobs.

It's already happening in the auto market, where car sales have risen from dismal levels of less than 10 million per year in 2009 to a rate of more than 14 million so far this year. Many economists expect to see a similar trend in housing, though it will take longer to materialize. But once home buyers feel housing prices have bottomed out for good, a housing rebound could be the very thing that cements a recovery.

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There's a lot of money on the sidelines. Big companies are sitting on as much as $2 trillion in cash that they've been reluctant to spend. Many private investors are hoarding cash as well, or keeping their money in super-safe securities such as low-yielding treasury bonds, since they're still shell-shocked by the volatile markets of the last few years. "Investors tend to extrapolate from the most recent past," says Mark Luschini, chief investment strategist for Janney Montgomery Scott. "We have to break the thinking that what we've seen over the last 12 to 18 months is what will happen in the future."

Once CEOs and reluctant investors start to become convinced that the worst is over, they'll begin to deploy all the money they're sitting on, another key step toward building a self-sustaining recovery. There may still be a few more hurdles before that happens. But every day that passes without an economic disaster represents one additional step toward a recovery that actually feels like one.

Rick Newman is the author of Rebounders: How Winners Pivot From Setback to Success, to be published in May. Follow him on Twitter: @rickjnewman

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