The Economic Recovery Is Toast, But There Is A Silver Lining.

Much to the chagrin of the public relations machine comprised of mainstream economists and strategists, the highly anticipated classic cyclical recovery appears to be AWOL. After the sharpest recession in modern times during the first half of 2009, conventional wisdom suggested that a V-shaped recovery was well underway with heady 4% real growth driven by self-sustaining private sector demand. Upon closer inspection, the recovery has been alarmingly anemic and now, even that halting performance is loosing altitude.

Let's briefly dissect what 0% policy rates, ~$2 trillion of quantitative easing, and a 13% federal budget deficit has provided us. At its pre-crisis peak in Q3 2008, US nominal GDP (IE real top-line GDP measured in Joe Lunchbox's pay check dollars, not US government "inflation-adjusted" dollars) was $14.547 trillion. For Q1 2010 with the recovery seemingly well established, nominal GDP was $14.601 trillion. So, let's see, over the past six quarters with unprecedented monetary and fiscal stimulus as the lead dog, the US economy has managed to grow by a whopping .37%. That's right, about 1/3 of 1%. On an annualized basis, that equates to .25%. That pales in comparison to to long-term historical average nominal growth of nearly 7%!

The composition of that growth is equally troubling. First, the public sector was a net negative contributor despite massive federal stimulus as the budget-constrained state and local governments more than offset the outsized federal spending. Second, roughly half of all recent growth was from the rebuilding of depleted inventories which is obviously a non-recurring phenomenon. Consumption provided the balance of the growth. It seems a tad bit curious that with the unemployment rate hovering around 10% and consumer credit experiencing never-before seen contraction that private sector consumption could be a growth contributor. Perhaps Meredith Whitney's theory yesterday on CNBC is correct - that consumption has been artificially boosted by the mortgage modification programs which have allowed thousands of households to temporarily reside in dwellings that are free of mortgage payments or rent of any kind.

Fast forward to today. Virtually all leading indicators are pointing down. The housing market has soured anew on the heels of the expiration of the home buyers tax credit as measured by the weekly mortgage applications data. The labor market has stagnated as well, evidenced by the rise in the four-week moving average of initial jobless claims since the beginning of April. Moreover, The US dollar has rallied smartly since the start of the year which is certain to represent a headwind to export demand and repatriated earnings during the back half of the year. Quantitative easing is over, and fiscal tightening at the state and local level is becoming pervasive. China is tightening and Europe has embarked on an emergency austerity plan in an attempt to ring-fence its currency crisis. US leverage ratios remain at all-time highs of roughly 370% of GDP providing little room for incremental debt as a growth engine. In short, the nascent recovery is toast, and the markets have not priced in this reality. Contrary to popular positioning, stocks and yields are headed lower.

I do think there is room for longer term optimism. Recessions are a fundamental part of capitalism. However, the short-sighted culture of today's policy bodies has taken the opposite tact, going out of their way to prevent losses, foreclosures, or pain of any kind. To me, that sounds more like communism than than capitalism. To the extent that the developed world is on the verge of a cleansing recession where redundant capacity is shuttered, balance sheets are de-leveraged, and markets are free of monetary manipulation, a self-sustaining global recovery can then begin in earnest, driven by the exciting potential of the developing world - reason for optimism to be sure.