Somewhere Short of a V
Economic growth is on tap for 2010 -- but it won't be as strong as it might have been.


David Malpass

Are we in the midst of a V-shaped recovery, where the economy rockets back to robustness following a painful downturn? Are we witnessing the short-lived acceleration that precedes an economic double-dip, otherwise known as a W-shaped recovery? Or are we entering a “new normal,” where the economy expands, but at levels that are well below those of previous decades?   

These questions are paramount in the investment community, and my answer is somewhat in between.

An expansion of the U.S. economy will certainly continue into 2010, supported — for now — by the Federal Reserve’s near-zero interest rate and a major swelling of the federal government. While it may not produce a full V-shape recovery — with sustained growth of 4 or 5 percent or higher — the U.S. economy is probably strong enough to perform in the 3 percent range. This should be enough to get us through the many debt restructurings that will be needed in 2010, and to survive the derailment risks relative to the public-sector expansion and the continued fiscal chaos.

Jobs and autos support this forecast.

Jobless claims have broken below the 500,000 mark, with job growth in the Labor Department’s payroll survey likely to restart in January. The major public-sector hiring being spurred by Washington also will add materially to employment and personal-income growth in the first-half of 2010.

As for the auto sector, auto sales moved above a 10 million annual rate in October and topped 11 million in November and December. Ford recently forecast industry sales of 12.5 million vehicles in 2010, which would be a 20 percent increase from the 10.4 million rate of 2009.

That said, there are several factors that argue in favor of above-trend, V-like growth in 2010, meaning quarters when GDP growth will be well in excess of 3 percent.

Historically speaking, after a deep recession, inventories rebuild, pent-up demand appears, and output partially catches up to the previous trend line, all of which propel above-average growth.

So far, inventories have declined and sales have recovered to the point that the inventory-to-sales ratio has dropped toward historical lows. And the still-low level of auto sales, and even lower level of domestic auto production, means there is a good potential for sharp gains in this important category.

And then there’s the power of animal spirits, meaning the natural tendency of people to grow and invest. Small businesses may find ways to work around the ongoing cutoff in bank lending. And a period of re-leveraging could emerge, marked by growth in private-sector debt and the release of pent-up demand as businesses and consumers make up for delayed purchases. If the animal spirits take hold in 2010, the recovery would accelerate.

But the risks cannot be overlooked. Though I don’t expect it, a double-dip recession is still possible in 2010 OR 2011. Should this materialize, Washington overreach would be the primary culprit: Passage of a bad health care bill (one that forces pronounced federal intrusiveness) could set a precedent for an anti-growth tax hike in 2010; the financial and regulatory reforms now being discussed in Congress are unattractive from an economic-growth standpoint; the tenuous U.S. debt position looms large, with Congress having extended the debt ceiling only through February 2010; and some risk of retroactive tax increases persists.

There are non-Washington risks to growth, as well, in large part stemming from the need for aggressive debt restructurings across the economy. Small-business finance remains a big problem, and the reorganization of the mortgage sector will continue to act negatively on the economic expansion. Meanwhile, at the state and local levels (just like the federal level), the path of least resistance — for the moment — is toward higher tax rates.

The net result? Real economic growth around 3 percent for 2010, along with higher-than-necessary unemployment, seems a realistic bet. That’s short of a V, but well above the W and new-norm scenarios (not to mention the dreaded L, or persistently awful economic performance). In other words, a welcome recovery — though not as strong as the U.S. has shown the capacity for in decades past.

– David Malpass is president of Encima Global.