Author: Christopher H. DeVoe CFA

Economists are creatures of habit: we love a normal business cycle. You know, the kind that start out when consumers, aided by a little Government pump priming, get out from under the covers and spend a little more money, then businesses find their inventories are a bit too lean and they order a little more from manufacturers, who then call a few more employees back to work, etc. This makes it easy — you look at past economic cycles, increase your forecasts for economic growth a little each quarter and, voila, the economy recovers in a year and a half to two years. The positive feedback loop of more spending causing more hiring, then more spending, then more hiring, builds on itself. Recession over!

But, alas, this time around, the underlying condition of the consumer has thrown a monkey wrench into the process. Americans spent the past 15 years accumulating assets and spending largely with borrowed money; indeed, the average household now has 50% more debt, compared to their income, than in 1995. In Finance 101, I was taught that saving represents deferred consumption — I save by not spending now — while borrowing shifts spending from the future to today. Well, that future is now. Consumers are concentrating on paying down debt, and will continue to do so for several years. Since the consumer is 70% of spending, this will prolong the current downturn, probably into 2011. And, the positive feedback loop is derailed: reduced (or deferred) spending leads to layoffs, which reduces spending further, leading to more layoffs. etc. Small businesses are finding it harder to get credit and, if they do locate funding, may not be confident enough to spend it. True, stimulus spending by the Federal government, and tax breaks to purchase cars and homes, have helped offset some of the decline. But the cost to create (or prevent the loss of) each job through the stimulus program is well over $150,000, so this cannot be the answer to replacing the eight million jobs lost thus far in the current downturn. Therefore, it seems likely that the unemployment rate, which just reached the 26-year high of 10.2%, will be close to 11% by mid-2010. I forecast that the US economy will shrink 3.5% in 2009 and 1% in 2010. Inflation will remain muted, although the lower prices of most items will be offset by higher costs of imports such as oil, due to the weakness in the US dollar. Growth should resume in 2011 and continue at a slow rate through 2015. We cannot spend our way out of the current recession as we have in normal downturns. The recovery will be anything but normal, confounding economists and disappointing the American people.

Christopher H. DeVoe CFA is the Chief Investment Officer of Constellation Asset Management, Inc., an investment advisory firm located in Fayetteville, New York. Mr. DeVoe can be reached at (315)449-1820.