A Developed World With Only 1% GDP

The US, EU, UK, and Japan were supposed to emerge from a great recession this year. The experience of past recessions would indicate that GDP should pick up to 3% or 4% and remain at that rate for several years.

Past experience has not turned out to be a reliable guide this time. Japan reported that its Q2 GDP rose by only .1% in the second quarter. That puts it on a .4% pace for 2010.

The Q2 GDP improvement in the US was 2.4% based on initial reading. The number may be revised as low as 1% when trade deficits are factored in. Unemployment, consumer confidence, and the real estate markets have caused a number of economists to sharply revise downward their second half growth guesses. What many of them hoped was a “jobless recovery” is now a recovery hampered by job losses.

The EU reported encouraging GDP numbers for the second quarter. But, if Germany is backed out of the figure, it does not look nearly so bright. Many of the economies of Europe are still barely growing, and some, like Spain, continue to shrink.

A developed nation growth rate of 1% in the second half would have profound effects particularly on recoveries in employment and the beaten up financial sector. Unemployment in the US will hover at the 10% level because business will lack both customers and credit. Banks are still shy about lending, particularly to smaller businesses. Large companies have been able to raise money inexpensively in the capital markets, but often this is to replace other debt on their balance sheets which means that their financial situations do not improve as much as it first seemed. And, the need for additional capital will throttle back without any cause for expansion.

The recovery of the banking system has been based on both the lessening presence of toxic assets on balance sheets and falling write-offs for real estate loans, both commercial and residential. Investment banking activity has also bolstered profits at the largest banks. Financial reform and a faltering economy will hurt institutional revenue. Loan losses will raise problems, expecially at regional and community banks. The FDIC still has a great deal of work to do as it closes weak banks.

There has been a good deal of talk about 2% or 3% GDP growth being the “new normal” for the large developing nations. The figure may actually be closer to 1%. The will undermine many of the austerity programs meant to cut deficits. Governments cannot tax income that does not exist.

The developed world economic outlook has changed, and it has only taken a few months to do so.

Douglas A. McIntyre