Why U.S. Economic Growth Will Remain Sluggish for Years

The U.S. economy is no longer in a freefall (as it was witnessed in Q3 2008 and Q1 2009) and the Q2 2009 GDP numbers are indicative of the same. There is optimism about the economic growth returning to positive zone and some economist are also talking about robust economic growth in a year or two. However, in my opinion, the U.S. economic growth will remain very sluggish for several years. In other words, U.S. will not return to peak economic activity (witnessed during 2006 and 2007) for maybe the next five years.

Before I give the reason for this conclusion, we must understand what lead to the economic growth in the U.S. during the period 2000-2007. During this period, debt in U.S. grew by $21 trillion and that lead to a GDP growth of $4 trillion. In other words, every $1 debt lead to a incremental impact on the GDP by 20 cents. So clearly, it was a growth lead by massive leveraging and artifically low interest rates. The easy lending standards also lead to the housing bubble which created a wealth illusion and prompted Americans to spend beyond their means.

Historical Trend of Consumption as a Percentage of GDP

The above graph shows that Consumption as a percentage of GDP averaged 62.6% during the period 1960-86. This, however spiked up, primairly post 2000 and peaked out at around 72%.

So one can safely assume that post 2000, the economic growth in the U.S. was lead by excessive leveraging, excessive consumption and illusionary wealth creation aided the two processes.

But Currently, the following is evident

Consumer Credit Growth Chart showing Credit Growth Slumping

Personal Savings Rate is Increasing

Unemployment Rate is Soaring Higher

To me, all this points to the fact that the consumer in general would not be back to a high spending spree for years to come. The consumers have just started to deleverage and this ideally should be a long process. At the same time, higher unemployment ensures that consumers are still cautious. This leads them to become savers from spenders as there is always a fear of job loss.

So, in my opinion, Consumption as a percentage of GDP has peaked out in the U.S. and will be trending downwards for many years to come. This will surely have a negative impact on GDP growth.

The question that comes to mind is - If consumption and consumer credit is falling so sharply then where is recovery coming from.

The recovery is being lead by the government sector and the evidence of the same is the massive deficits the Government has managed to create. Below is another evidence of the fact that the private sector is still contracting.

Tax Receipts in the U.S.

The total tax receipts (personal and corporate) are still on a sharp decline in the U.S. So where is the economic recovery?

Thus, what the Government can do is to artifically support the economy through massive quantitative easing. But what the government can't do is to bring back the economy to a high growth phase so soon. When the real economy is so weak and excessive money is printed, all the excess money goes into speculation. That is what is happening right now. So all the excess money is pouring into equities and commodities and that is giving a general feeling that the economy is recovering (since equities and commodities are going up).

The following is to be kept in mind about bubbles in any asset class:

Once the bubble goes bust, the recovery does not come for years.

Example -1

The Japan stock market bubble went bust in 1989-90. The Nikkei was at 39,000 at that time. 20 years later, the markets are still hovering at around 10,000.

Example -2

The Nasdaq bubble went bust in 2000-2001. 10 years later, we are no higher then what we were at during that point of time.

The same go for bubbles in any asset class. Examples are numerous from the past. But what I wanted to emphasize was that the following bubbles have gone bust post the 2008 crisis in the U.S. -

1) The bubble in the Financial Industry

2) The Credit Bubble

3) The Consumption Bubble

These will ensure that U.S. economy does not get back to fast paced growth anytime soon. Another bubble that is building up will ensure that the American's are again burdened with further debt. That is the bubble in the U.S. bond market.

It remains to be seen where this game of creation and destruction of bubbles ends and where does all this lead a common American (or for that matter every common man in this world) to.