U.S. Economy May See Its Slowest Recovery Since 1945

By Rich Miller

Sept. 14 (Bloomberg) -- The U.S. recovery may be the slowest since World War II to regain all the ground lost during the recession, even if economists’ more optimistic forecasts for expansion turn out to be right.

The slump this time was so deep, said JPMorgan Chase & Co. chief economist Bruce Kasman, that the 3.5 percent average quarterly growth rate he sees in the next year won’t be enough to bring gross domestic product back to its $13.42 trillion pre- crisis peak. That’s in contrast with the last 10 recoveries, when GDP returned to its previous levels within 12 months.

The result: A year after the Lehman Brothers Holdings Inc. bankruptcy helped drive GDP down to an annualized $12.89 trillion in the second quarter, there’s still “plenty of malaise,” Kasman said. Unemployment may remain close to the current 26-year high of 9.7 percent through 2010, upsetting voters ahead of mid-term Congressional elections and forcing officials to keep interest rates near zero and the budget deficit around this year’s record $1.6 trillion.

“This will be the most disappointing recovery,” said Kasman, whose forecast compares with the median estimate of 2.5 percent growth in a Bloomberg News survey of economists.

The U.S. might not recover the 6.9 million jobs and the $13.9 trillion in wealth lost during the recession until about the middle of the decade, said Mark Zandi, chief economist at Moody’s Economy.com in West Chester, Pennsylvania. The unemployment rate may never get back down to the 4.4 percent low of 2007, he said.

Cyclical Revival

Stock prices may take three or four years to reach their previous highs as the cyclical revival of the economy gradually boosts corporate profits, said Allen Sinai, chief economist at consulting group Decision Economics in New York.

“It will be a bull market, but not a roaring bull market,” Sinai said. He sees the Standard & Poor’s 500 stock index rising to 1,100 by the end of 2009 from its close of 1,042.73 on Sept. 11. The index hit a record 1,565.15 on Oct, 9, 2007, and then fell to a 12-year low of 676.53 on March 9, 2009.

Companies, particularly retailers such as Macy’s Inc., may have to adjust as consumers buy less. Household spending as a share of GDP might fall to its long-run historical average of 65 percent from 70 percent in the past decade as people opt to save more, according to economists Peter Berezin and Alex Kelston, of Goldman Sachs Group Inc.

Biggest Drop

The restrained performance that is forecast for the economy reflects both the depth and the origins of the recession, which began in December 2007. The 3.9 percent decline in gross domestic product was the most since World War II.

While Nippon Yusen K.K., Japan’s largest shipping line, has been able to raise rates on container services to the U.S., it continues to lose money on the business. Mikitoshi Kai, head of investor relations for the Tokyo-based company, said in an interview that “we need to increase rates by a lot more to make a profit.”

The decline has been a “balance-sheet recession,” says Richard Koo, chief economist at Tokyo-based Nomura Research Institute. Those take time to recover from, as once highly leveraged banks and consumers gradually reduce their debt, he said.

Fed Outlook

Policy makers may have to keep interest rates low and the federal budget deficit high to push the economy forward as financial institutions and households adjust. Federal Reserve Chairman Ben S. Bernanke and his fellow central-bank colleagues might hold their target for the federal funds rate between zero and 0.25 percent through 2010, said Kasman at JPMorgan in New York, the second-largest U.S. bank. That’s the rate at which commercial banks lend each other money overnight.

“The Fed may need to maintain fairly low interest rates over a period of many years,” Berezin and Kelston, of New York- based Goldman, the fifth-biggest U.S. bank, wrote in a Sept. 9 report.

On the fiscal front, the deficit will total $1.29 trillion in the year starting Oct. 1, boosted by a $787 billion stimulus package and aid to banks, according to Maury Harris, chief economist in New York at UBS Securities, a unit of Zurich-based investment bank UBS AG.

“I suspect the deficit will continue to balloon for years,” said Kenneth Rogoff, a former chief economist at the International Monetary Fund who is now a professor at Harvard University in Cambridge, Massachusetts.

‘Wild Card’

The “wild card” is the political impact the economy’s chronic difficulties will have on mid-term Congressional elections in November 2010 and beyond, Kasman said.

Democratic lawmakers in the House of Representatives are particularly vulnerable if voters blame President Barack Obama for a sour economy, said Nathan Gonzales, political editor for the Rothenberg Political Report in Washington.

Since 1945, the party that controls the White House has lost an average of 16 House seats in a president’s first midterm election, according to the Cook Political Report. Obama’s Democratic Party currently has 256 seats in the chamber, compared with 178 for the Republicans.

In the past, deep recessions have often been followed by rapid recoveries. That’s what happened in 1982-83 as the economy surpassed its previous peak in about six months, thanks to a 7.2 percent surge in growth. Behind the turnaround: aggressive monetary easing by the Fed, which brought short-term interest rates down to 8.5 percent from 15 percent in 1982.

No ‘Gas’

“We thought that if we really stepped on the gas, the economy would take off, and it did,” said Lyle Gramley, a senior economic adviser for New York-based Soleil Securities who was a member of the Fed’s board at the time. That option isn’t available to the central bank now as the overnight interbank rate is at zero.

The Fed has also been hampered by a credit crunch that has restricted the flow of money from lenders to borrowers, Gramley said. Banks, faced with mounting credit losses, have tightened terms and standards on loans to businesses and households since the middle of 2007, according to the Fed’s tri-monthly survey of lending officers.

That’s akin to the situation in 1991-92, when tight credit in the wake of the savings-and-loan crisis restrained the recovery, according to Gramley. It took about nine months for the economy to return to pre-recession production levels as growth clocked in at an average 2 percent.

Borrowing Falls

Household borrowing fell by a record $21.6 billion in July to $2.5 trillion, the Fed reported on Sept. 9. The drop was the sixth straight monthly decline, the longest since the 1991 credit crunch.

Behind the fall: Banks are becoming stingier in handing out credit while consumers are growing more wary of taking on more debt. The savings rate rose to a 14-year high of 6 percent in May before falling to 4.2 percent in July, government data show. It was 1.3 percent at the start of 2008.

Retailers are taking notice of the increased consumer thriftiness, including Cincinnati-based Macy’s. Chairman and Chief Executive Officer Terry Lundgren told Bloomberg Television on Sept. 8 that the second-largest U.S. department-store company has reduced inventories “fairly significantly.”

Home builders may have to adjust, too. Sales of new houses jumped 9.6 percent in July, the most since February 2005, to a 433,000 annual pace. That was still less than half the 923,000 average since the start of 2000.

The increase in sales has helped boost the price of copper. Copper for delivery in three months closed Sept. 11 at $6,250 a metric ton on the London Metal Exchange. That compares with $3,231 on Jan. 2 and a high of $8,730 in April of last year.

“There were huge excesses built up during the expansion,” Sinai said. “It may take the economy a few years to get back to its previous peak.”

To contact the reporter on this story: Rich Miller in Washington rmiller28@bloomberg.net