Thursday, February 25, 2010

Someday We’re Going to Party Like It’s 1995

“I was dreamin’ when I wrote this, forgive me if it goes astray”

Everyone is asking the same question: When will things get back to normal? I think the more important question is: What is normal? We tend to want to define normal as the conditions that existed before The Great Recession hit.

But 2007 was far from normal. We had an economy fueled by an artificially stimulated housing market and out of control conspicuous consumption. This was funded by large financial entities taking extreme risks and consumers running up unreasonable levels of debt. This was very abnormal. We would like it to be normal because times were so good, but it was far from normal.

The rest of the aughts (00’s) were not normal either. The beginning of the decade featured a recession caused by the dot com bust and after that came the run up of the housing bubble. The 2001 recession turned out to be mild because we had two bubbles going at once. The dot com bubble burst, but the growing housing bubble kept consumer spending propped up.

The period of 1996-2000 was not normal. This was the run up of the dot com bubble and the beginning of the housing bubble. In addition, Robert Rubin (Treasury Secretary under Bill Clinton) figured out that you could have strong economic growth with low inflation by importing cheap goods from China. This strategy resulted in an erosion of the manufacturing base and created high trade deficits, but it resulted in an increase in the standard of living, so it was deemed to be good. We tend to enjoy abnormal, as long as it provides positive outcomes.

Many charts of economic and consumer trends start to make an unusual accent around the 1994-1996 time period, so I am deeming 1995 as the last year of “normalcy”. This is significant because it was so long ago. If you are under 40 years of age, you have no concept of “normal” because you didn’t have enough business experience at the time to understand it. If you are older than 40, you may just have trouble remembering that far back.

I can’t tell you when we will get there, but here is what I expect the “new normal” to look like:

Interest Rates: The current prime rate is 3.25%. It was 8.5% in 1995. Interest rates may spike due to inflation but should eventually return to levels resembling 1995. Mortgage rates were around 10% in 1995. Banks will return to the more tradition ways of making money. No more wild speculation, they will have to earrrrrrn it.

Inflation: Inflation may also jump in the short term as the Fed has a big challenge ahead. It has to try to put the brakes on the monetary stimulus by pulling money out of the system (let’s hope the Fed isn’t driving a Toyota!). Inflation was only 2.8% in 1995 and 2.7% in 2009, but now you have too much money in the economy and too much debt. The Fed will eventually stabilize the inflation between 3.5%-5.0%.

Home Ownership: Home ownership peaked at 69% in 2007. It was 64% in 1995. We don’t know how far this will drop before housing stabilizes. Ultimately, the 64% rate seems reasonable. Demand for housing will be impacted by the higher interest rates and lower ownership percentages.

Savings Rate: The savings rate was 1% in 2008. Some economists predict it will hit 8%. The 1995 rate was 6%. After the smoke clears and people become more confident, look for the savings rate to settle in around 4%-5%.

Imports/Exports: Imports from China were $268 million in 2008 versus $33 million in 1995. Of course we can never get back to 1995. However we have to implement fair trade practices and programs that increase exports and decrease imports. Trade balances have to even out in the long run and we have been on an import binge for over 15 years.

Taxes: We have created a huge federal debt due to reckless spending. Taxes may need to be increased to pay for all the bubbles and excesses of the past 15 years (you know what they say about paybacks). Expect a value-added tax to reduce the debt. This could even work if the tax has an end date and the money is used for debt reduction only (and you trust the politicians to do this, right?). Also expect an increase in the gasoline tax as the government attempts to squeeze every nickel it can out of people without raising income taxes.

Unemployment: Unemployment was between 5.6%-6.1% in 1995, it is around 10% now. We sacrificed some jobs by importing too many goods. We sacrificed more jobs due to consolidation. While mergers increase efficiencies, at some point you stifle competition and create “too big to fail” banks.

Under these conditions, it will take time to bring down the unemployment rate. A new, intelligent, job creating strategy is needed. Perhaps we can go back to the old days when the country relied on its advantages in innovation and education to provide economic growth. Without a new strategy, it may be difficult to get unemployment under 7%.

Consumer Spending: The rate of growth will decline due to a myriad of factors including, increase savings rate, higher interest rates, higher unemployment, higher taxes, and higher inflation.

GDP: Is very difficult to predict GDP as we pull out of this recession under very abnormal circumstances. Maybe 2%-3% average GDP growth is all we can expect for a few years based on all the factors listed above.

Two thousand zero eight party over
Ooops, stop this jive
Someday we gonna party like it’s 1995

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