[iForex]

The US recession officially started in December 2007 and is now already as deep and as long as the two worst recessions in the last half century, 1974-5 and 1981-2. Including Q1 2009, with most forecasts looking for a decline of GDP in the 3-7% range, the peak-to-trough decline in GDP so far is about 3% which is similar to 1974-5 (-3.1%) and 1981-2 (-2.9%). Recently some data releases have suggested that the pace of decline may have slowed and the stock market has staged a major rally, raising hopes that the recession is nearly over. But in the view of some market analysts, it is far from over, though they may have seen the worst of the initial decline now. They expect GDP to decline further in Q2 and again in Q3. Unemployment will climb to over 10% and a recovery will only begin late this year at the earliest and then only at a slow pace. The forecast suggests that the US will suffer the worst recession since the Second World War and, moreover, we still see downside risks to that. The OECD Secretariat's latest forecast has an even larger peak-to-trough decline and recovery only beginning in mid 2010.

The US faces major economic adjustments As is now
widely understood, the model of economic growth which drove the economic boom from 2001-7 is broken. Worse, it has left the financial system in disarray and households with reduced wealth and too much debt. The underlying problem was the housing bubble which inflated during the boom years and has now been deflating since mid 2006, with the pace of decline accelerating recently. There are three related adjustments necessary before the economy is healthy again. First, house prices need to come down to normal valuations. The S&P Case-Shiller index has already fallen 29% (January data) but measures of house prices in relation to rents and incomes suggest that a total fall of at least 40% (peak-to-trough) is required before valuations are back to normal levels. Unfortunately, the further house prices fall, the greater the pain for both banks and households. The second adjustment required is for the household savings rate to rise. During the bubble years it went almost to zero. So far it has rebounded to the 3-4% range, bringing the sharp contraction in consumer spending and GDP in the second half of 2008. A further upward move, of at least the same scale, is necessary, taking the savings rate up to the 6-10% range. This will hold back consumer spending for some time. The third adjustment is for the financial sector to be made whole again, by removing the bad assets (one way or another) and finding new capital to fill the gap.