Consumers saddled with debt are finally being virtuous, unwinding the leverage they built up in the years before the recession, and boosting their savings rates to around 4% or 5%. That goes hand in hand with sapped confidence. The values of their houses have shrunk with the collapse of the housing bubble, their stocks buckled in the market crash, and their credit has evaporated. They likely know people down the block who have lost their jobs. So the extra money that would otherwise go toward new cell phones, cars, TVs and shoes is now going to pay down obligations. The good news is that in the long term, their more parsimonious behavior will stabilize the economy. But in the short term it means a lot of pain, since personal spending makes up more than two-thirds of the GDP.
The resulting deflationary spiral has prompted the Federal Reserve to fight back with extra monetary stimulus, lowering short-term interest rates to zero. When the Fed announced further stimulus in November-a quantitative easing initiative to buy up some $600 billion in long-term Treasury debt-to get back to its 2% inflation target, some economists were less than gaga about what they saw as a new round of froth. Opponents say the extra liquidity won't help much, and fear a nasty hangover from the inflation that will inevitably result.
Mark Luschini, the chief investment strategist at Janney Montgomery Scott in Philadelphia, says the quantitative easing plan seemed like a good idea when it was first floated in the middle of the year. "It seemed like it was a necessary evil, and in fact just by talking to the notion that the Fed was going to be moving toward pumping more liquidity into the marketplace, equities rallied about 15% prior to the actual declaration. So jawboning the notion of it did the work." But now there's a camp that thinks only organic growth will do, and these people are calling for the Fed to raise its liquidity siege.
Scott Tatum, director of The Advisor Institute at AllianceBernstein, was more severe when talking about what could happen if there's too much monetary easing when he spoke at the NAPFA conference in San Diego on September 22. "I know the fire is not going really well right now, but when you keep pouring gasoline on it, when the spark hits, it burns your eyebrows off. It's not good. It'll be a fireball when it comes out."
As some discuss whether monetary policy has led the U.S. into a liquidity trap, others ponder what exactly would help goose the economy forward. Democrats and newly empowered Republicans in the House of Representatives have begun squabbling over whether the taxes on the richest Americans should increase with the expiration of marginal tax cuts enacted in 2001 and 2003 (the so-called "Bush tax cuts.") If taxes rise on the wealthiest on January 1, it might crimp economic growth. After all, luxury goods providers are starting to see their inventories moving again. But if taxes remain at the marginal rates of the Bush era, an already yawning government deficit could grow to an even higher percentage of GDP over the next 10 years, according to the Congressional Budget Office. That also means a greater risk of inflation in the long term.
In a spirit of compromise (or procrastination), President Obama and House Republicans on December 6 reached a deal to extend across-the-board cuts at all income levels for another couple of years, in exchange for extended unemployment benefits, thus putting another temporary fix on tax cuts that were supposed to be temporary in the first place.
In any event, the uncertainty about taxes, as well as the effects of the health care reform legislation and the expiration of some government stimulus packages, has eroded the confidence among small business owners and corporations, says Krosby. "If we can ease the credit, ease credit particularly for small business owners, and also get some clarity on the tax situation, and if we can get small business owners engaged in the economy, we could see GDP move a little bit more than where it's been sort of crawling toward," she says.
Small businesses make up 50% of new job generation, which makes them the "central part of the economic mosaic," Krosby says. However, uncertainty about growth and their lack of access to credit have made smaller employers finicky about hiring new employees.
The biggest obstacle in getting jobs to the unemployed was the output gap. Capacity utilization was running at about 74.8% in October, down from its average of 80.6% from 1972 to 2009. That means frugal companies are making more profits off less labor. U.S. companies, even though they have become profitable again, aren't interested in hiring American employees until they see GDP rise to higher levels.
"Larger companies are very mindful of their bottom line," says Krosby. "That's been a very clear theme coming out of the last couple of quarters-that until they see U.S. GDP picking up or demand picking up in the U.S., they are going to be very nimble and very careful about their hiring here in the U.S."