Massive government intervention has helped stop the economic decline, but it also has slowed the closing of the imbalances that pushed us into the recession in the first place, consumer overspending among them.
With savings rates near zero and debt levels hitting a record high of 120 percent of annual income at the onset of the recession, spending had to come down. And it did, with the expected results for the economy. Now personal savings rates are running slightly over 3 percent of income - still too low, but moving in the right direction. More importantly, consumer spending is on the rise as well, which is clearly good for the economy in the short run. But the fact that spending is up should raise warning flags. After all, real income was battered by the loss of jobs and has yet to recover. How can Americans be spending and saving more even as they earn the same amount?
That good trick came via the record tax cut Americans received in 2009 as part of the stimulus program. Americans had been paying roughly 12 percent of their income in taxes at the start of the downturn. Last year that number was down to a record low of 8.8 percent.
It may be the case that savings is larger than it appears - after all, millions of people are enjoying housing without bothering to pay the mortgage. But any savings from this can't be that much. If each of the 6 million nonperforming mortgages in the nation cost on average $1,500 per month and went unpaid for a full year, this still would boost overall consumer income by only 1 percent. That's not large enough to distort the statistics. What this means is that consumer spending as a share of income is at a record high-and rising. The consumer part of the problem hasn't been solved.
Of course, one solution would be for the government to make the tax cuts permanent. Unfortunately, this is not a valid option. The U.S. government had serious debts coming into the recession. The Bush administration chose to fund its Middle East adventures through borrowing instead of tax increases. For a while the public sector needed to borrow an amount equivalent to 6 percent of the gross domestic product, which is roughly the level of borrowing through previous Republican administrations. But the bailout plans took this to a level not seen since World War II, with the current pace of borrowing at 11 percent of GDP, or $4 billion per day.
This puts us close to the Greek level of fiscal deficits. Fortunately, the world's lending community doesn't put us in the same category of risk, so our government still pays relatively low rates on its debt. But how long we can continue on this path is unclear, particularly if inflation sets in. And is such behavior ethical? Should the next generation of Americans be held financially responsible for this generation's inability to spend at a reasonable level?
Taxes will necessarily increase in the next two years, though the speed at which they'll rise is not yet determined. The current budget proposal from the Obama administration extends some middle class tax cuts but allows tax rates to go up on higher-income households. This will put consumers in the difficult position of having to reduce spending or savings. The first is bad for the short-term health of the economy, the second is bad for long-term health.
The only real hope for the administration is that income growth will return with enough speed to allow Americans to pay higher taxes without cutting back elsewhere. But that seems unlikely to occur. The labor markets remain weak, and the last few recessions seem to indicate that the jobless recovery is a standard part of a modern recession. It may be even worse this time around. Because of the shift in economic drivers, away from housing and consumer spending, many laid-off workers will need to be retrained in new fields before they become employable. This may be why job creation is such a top policy priority.
Though we have become more optimistic about the economy in the short run, we have also become more pessimistic in the medium run. A solid 2010 does not necessarily mean a good 2011 or 2012. The growth happening now is due to fiscal policy - which succeeded in stabilizing the economy, but comes with a cost, including an out-of-control federal deficit. The nation seems to be trading its private bubble for a public one, swapping one set of unsustainable drivers for another. And as with all bubbles, the pop, when it occurs, will likely prove painful.
