Last Look at 2008 and the Economy

It is clear that 2008 was not a very good year and it is official that the current U.S. recession started already in December 2007.

So how far are we into this recession that has already lasted longer than the previous two (1990 and 2001 recessions lasted 8 months each)?

I believe the U.S. economy is probably only half way through this recession. I believe that this will be the longest and most severe recession in the post World War II period.

Even if Barack Obama is able to get the Republicans to back his stimulus package, the U.S. GDP will continue to contract throughout 2009 for a cumulative output loss of 5% and a recession that will last close to two years.

One last look at 2008 will reveal a very weak fourth quarter with GDP growth contracting -6%, in the wake of a sharp fall in personal consumption and private domestic investments.

There is a good chance of real GDP growth contraction playing out through the year as follows: Q1 2009 -5%; Q2 2009 -4%; Q3 2009. -2.5%; Q4 2009 -1%, adding up to a yearly real GDP growth of -3.4% for the U.S. in 2009.

The U.S. consumer is at the center of the dynamics that will play out in the real economy in 2009, and it will not be pretty. Currently personal consumption in the U.S. makes up over two-thirds of all aggregate demand. So with indications that personal consumption will continue to contract throughout 2009 quite sharply as a result of negative wealth effects from housing and equity market losses, the disappearance of home equity withdrawal from the second half of 2008, mounting job losses, tighter credit conditions and high debt servicing ratios (the debt to income ratio went from 70% in the 90s, to 100% in 2000 to 140% now).

The wealth losses for households related to the fall in home prices are roughly $4 trillion so far, and are clearly bound to increase further as home prices continue to fall –eventually reaching the $6-8 trillion range.

This retrenchment of the U.S. consumer will result in a painful rebalancing in the economy that will eventually restore the saving rate of a decade ago.

Economy wide job cuts are expected, with big corporations and small enterprises, residential and commercial construction, financial services and manufacturing continuing to shed jobs at a strong pace. Moreover with structural shifts in the economy since the last recession, job losses this time will be more severe in the service sector, including retail, business and professional services and leisure and hospitality. So I am afraid that lay-offs are bound to continue. Unemployment might peak between 9 and 10% in 2010. Almost two years after the recession began we will still be feeling the effects on jobs. This will not even count those discouraged workers who leave the work force and are no longer eligiable for unemployment.

This could all lead to deflationary pressure in the economy.