History, law of averages say U.S. economy will recover

August 13, 2011|By Jay Hancock

In the late 1800s, while observing the width of peas, the height of men and the speed of homing pigeons, Sir Francis Galton came to a profound and comforting conclusion: Things return to normal.

The forces that move the world do not like extremes. Hurricanes and droughts don't define the weather. Nor do 9 percent unemployment, a decade of stock stagnation and cash of $1 trillion sitting idle in corporate treasuries define the U.S. economy.

I do not mean to dismiss the country's terrible situation or predict an imminent turnaround. But the principle of regression to the mean described by Galton, a pioneering statistician, promises that the United States will emerge from this slump in something like its old, robust shape. It's just a matter of when.

Signs of healing are there, if you look. American households saved $1 trillion in 2010, and this year they'll probably save a similar amount — more than triple the rate before the financial crisis, according to figures from the Federal Reserve. Consumers are shedding billions in debt.

For now, this hurts the economy. Money put in the bank or devoted to paying off credit card balances isn't being spent in stores and creating jobs. But today's savings finance tomorrow's purchases — with cash, not the unsustainable debt that caused all the problems.

Measured against profits and assets, American stocks are at their best price since the 1980s. The S&P 500 stock index pays annual dividend income that's almost as much (more than 2 percent) as interest from a 10-year U.S. Treasury note — supposedly a much safer investment. Thanks to all that cash, it might be argued that the companies' ability to continue payment is better than the government's.

The corporate cash pile is another form of saving that suffocates growth and hiring. But at least somebody on the planet is solvent. If IBM's bonds were as risky as Greece's, we'd really be in trouble.

Companies are starting to put the money to work. Business investment is rising, especially in software, computers and other equipment, the Fed reported last week — one of the few pieces of good news to emerge this summer.

Automakers have emerged from the depths. Strict new fuel standards will prompt them to invest in engineering and hardware. Utilities such as Baltimore Gas & Electric are spending large sums on "smart" meters and other equipment.

Unlike Japan and Europe, the United States is adding population at a healthy rate. Although retiring baby boomers are hurting the nation's spending power, their kids will soon enter prime time for purchasing, household formation and creativity.

Another positive: The feared crash in U.S. commercial real estate hasn't happened.

Residential real estate — slowly, slowly, slowly — is working through its historic excesses. Government mortgage giants Fannie Mae and Freddie Mac need to do much better at promoting the housing market by lowering strict qualification requirements for buyers and whacking principal balances on existing loans. But the lowest mortgage rates in modern history and continued falling prices will eventually clear the market of vacant and unsold houses.

The budget and debt-rating problems that have hurt the dollar could also plant a germ of revival. For years the currency has been overvalued. Now dollar weakness combined with inflation in countries such as China, some economists believe, could plant the seeds for an export renaissance. A lower greenback and higher foreign prices could make U.S. goods newly competitive on world markets.

Two years ago financial commentators were quoting Yeats, the Irish poet: "Things fall apart; the centre cannot hold." But Yeats was wrong about the long term. The forces of history are centripetal, not centrifugal. For the long term, things return to the center, the arithmetical mean.

The economy shrank at an annual rate of 0.3 percent from 2007 through 2010, the Commerce Department reported in an alarming revision last month. But since the 1940s, the mean yearly growth rate for the U.S. economy has been more than 3 percent.

Unemployment has been more than 8 percent for almost 21/2 years — a record. But mean unemployment since the 1940s is much less — below 6 percent.

The S&P 500 basically is at 1998 levels. But the mean annual increase in the big-company stock index since 1944 has been 7 percent. The average annual return jumps to 11 percent when you count dividends.

To be sure, millions of homes are still on the market. Billions in mortgages are still overvalued and need to be marked down on banks' books. Government is cutting employment the way the private sector did in 2009, which won't help anything.

This was a once-in-a-lifetime financial collapse. The economy could take until 2013 or later to return to normal, especially if the government policies fail to prompt growth. A double-dip recession is possible. Prices for stocks and homes could fall farther.

But regression to the mean teaches that the worse things get, the closer you are to improvement. The mean for the American economy is growth, innovation and jobs. Someday we'll get back to it.

jay.hancock@baltsun.com

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