Mohamed El-Erian’s term describing the new economic reality, “the new normal”, has been widely adopted by analysts and the financial media. The reason for its popularity is the profound and intuitive truth it conveys. This recession is not just another recession. (That is why “This Time It’s Different” was the subtitle of this blog for the first few months of its existence.) This recession is not going to give way to the same dynamic economy we have grown used to because it is more than an inventory and monetary correction; it represents a fundamental re-orientation.
The financial crisis has revealed the unsustainable nature of US growth over the last decade. The US consumer can no longer rely on rising asset prices—whether equities or real estate—as their savings vehicle. US companies can no longer expect light touch regulation and low interest rates. The 2008 financial crisis was a shock that readjusted the global economic system. Not just Wall Street is re-evaluating its business model. China has realized it can no longer rely on Western consumption and that it cannot continue fueling US credit by buying treasuries. The US has realized the un-sustainability of consumer and import.
The term “the new normal” implies that the financial and economic crisis has significantly changed the economic structure of the US. This implies the 2% growth and 10% unemployment of the new normal is a result of the crisis itself, but this is misleading. The truth is the underlying trends driving the new normal existed even at the peak of the bubble—they were just masked by the bubbles themselves.
Let’s take a look at the real estate bubble. One consequence of rising housing prices was consumers could spend more and save less since they had security in the high value of their home. (Therefore, the stock and housing bubbles created another bubble—a consumption bubble.) Another consequence of rising real estate prices was a increase of mortgage equity withdrawals, which is when people treat their home like an ATM and give up equity for cash (perhaps to buy a new Escalade or Suburban). Below is a chart from Calculated Risk showing mortgage equity withdrawals by quarter:
This consumption bubble had a huge effect on GDP. The following chart, from John Mauldin, who has written about this topic a great deal, shows how GDP would have recovered without MEWs. As you can see, without MEWs, our GDP growth would have been about 1-2%, about the amount of annual growth expected in the new normal.
It seems plausible to say the new normal would have started after the 2001 recession if it hadn't been for the new housing, stock, and credit bubbles. This is further supported by unemployment figures. 2003 was the first "jobless recovery," many analysts are expecting the same kind of jobless recovery for this recession and, considering the unrelenting rise in unemployment, this is very likely. The new normal is not as new as it seems, the difference is we don't have any bubbles obstructing our perspective. (Or at least for now anyway. Considering the recent astronomical rise in stocks, which El-Erian described as a "sugar high", we might soon have another bubble.)
