Vince Farrell: We See a Low Inflation, Slow Growth Recovery

Is was either Isaac Newton or George Santayana

One or the other of those guys, or maybe both, said "If you surround yourself with people better than you are, you will walk through the world on the shoulders of giants." Rule of thumb - if you are ever not sure who said something, use Churchill as your source. He said so much you probably have a 50/50 chance of being right. But to be surrounded by smart, capable people makes going to work a pleasure. Lyle Gramley joined Soleil a short time ago and has raised the level of debate several notches. He issued a report last week entitled "The First Year of Recovery." He looked at all the recessions/recoveries since WWII (save the one following the Korean War) and found some interesting stuff.

The average recovery in the four quarters following the nine downturns he studied was 5.8%.

Interestingly, following the deepest of the recessions - five of them averaging a -2.7% slump - the recovery was a strong +7.1%. For the four milder ones - an average downturn of -1.1% - the recovery was less pronounced averaging a +4.1% four quarter rebound. So the deeper the slump, the more pronounced the recovery. That makes some sense as you can imagine pent up demand building during a downturn. If that's all you knew, the guess would be for a sharp rebound now since the recent recession (I am presuming the recession is over or soon will be) has been the worst in many a year. But there are more factors to consider.

Net exports are usually a drag in the initial stages of US recoveries.

Since recoveries are not coordinated affairs - as the US recovers the rest of the world usually lags - a pick up here leads to US imports surging. Also, inventory restocking during a recovery is at least partly filled by imported goods which would depress the import/export comparison.

Surprisingly, consumer spending accounts for a smaller share of a recovery than it typically does in a normal economic environment. Growth in wage income is key, though, as consumer spending still supports around 60% of the recovery phase (consumer spending has been well above 70% of economic activity recently and has averaged above 66% for some time). A smaller increase in wages will bring about a weaker recovery. In the second quarter of 2009, wage and salary income was 4.1% below the same period last year. So if that is all we knew, we would be expecting a weak recovery. Lyle's conclusion is that wage income will not be strong enough to promote robust consumer spending. Unemployment is high and likely to rise for a while.

Inflation has been down the first year of a recovery in eight out of the nine periods studied which is a bit of a surprise.

The bottom line is we expect a low inflation, slow growth recovery. The natural inclination of the economy to rebound more vigorously from a deeper downturn will be blunted by lack of export growth and, more importantly, by the inability of the consumer to mount an aggressive comeback. Beside the historical data, we might add there is a need for consumers to accelerate their savings rate to repair their tattered balance sheets.