Recession 2009 – Are we out of Woods?

Saturday, January 23, 2010

Recession 2009 – Are we out of Woods?

The crisis in the financial sector that originated in 2007 had a catastrophic effect on the broader sectors of economy and what followed was worst global recession since Great Depression of 1929. We have correctly mentioned about recession setting in US economy in our article “2008 Challenges for India Based IT Services Companies” in March 2008 issue of Research Update. Sixteen months has passed since then and in this article looks at factors guiding economic revival, risks and opportunities arising out of changing world order.

Engines of US Economic Recovery

The financial crisis has affected all the major economies of the world with western economies in the midst of recession while growth has considerably slowed down in the emerging economies. It is expected that the emerging economies will be the first to revive and lead the global economic recovery but world is looking up for signs of revival in United States, the largest economy in the world representing more than 20% of the world economy.

The engines that have lifted the U.S. economy out of every recession since World War II will be of little help this time around. Inventory rebuilding, household spending, home construction and payroll growth — the forces that powered, to a greater or lesser extent, each recovery since 1945 — may not be of much help in 2009. A glut of unsold properties is keeping housing depressed, while job losses and an uncertain economic environment will discourage consumer spending. Companies may be reluctant to restock and rehire while their profits are squeezed.

Inventory swings played a key role in economic recovery following recession in 1973-75

Inventory swings played a key role in the 16-month recession of 1973-75 and the recovery that followed. Companies slashed stocks in 1974 and 1975 as demand dropped, and then rebuilt them rapidly the following year. That raised 1976 GDP by 1.4 percentage points, the biggest such contribution in 21 years.

Consumer spending and Housing sector powered economy after 1983 recession

Consumer spending and housing powered the economy out of recession in 1983, as pent-up demand sent purchases of cars and homes soaring. The unemployment declined at a rapid pace.

Housing sector contributed to recovery in 1992

In 1992, housing again was a big help. Along with capital spending, residential construction spurred the biggest contribution to growth from investment since 1984.

The economic recovery of 2009, which seems to be gathering pace, will be slow and driven by government spending which is in contrast to past rebounds, where growth was boosted by a robust revival of private-sector demand following the slowdown.

Green Shoots of US Economic Recovery 2009

Green Shoots is a phrase coined by Federal Reserve chairman Ben Bernanke, which he mentioned for the first time in a March 2009 television interview. The Fed president mentioned the term to describe signs of a thaw in frozen credit markets leading to economic revival.

We look at some of the leading economic indicators to determine if there are indeed green shoots of economic revival.

Stability in Financial Sector will restore the credit flow

The special measures that the Fed and other central banks of the world took seem to have yielded desired results in bringing stability to the financial sector. The record corporate bond sales and fall in LIBOR (London Interbank Offered Rate) that banks charge each other for loans suggest that that credit market is slowly reviving.

The fall in LIBOR is significant since it affect the cost of loans in wider economy, for both businesses and individuals. LIBOR (London Interbank Offered Rate) rates, a widely used reference rate for financial instruments across the world has witnessed significant decline. Six month LIBOR is currently at 0.98 compared to 1.16 a month ago and 3.09 a year ago. The low interest rate will improve corporate profitability and drive the investments.

Even the financial sector is becoming stables after months of volatility it will be sometime before permanent stability will be restored. As the governments support the big financial institutions, the small and medium ones are still vulnerable to failures as the consumer delinquency remains high amid declining housing market and rise in unemployment.

But the systemic risk to the financial system has receded as regulatory authorities are in better control of the situation than they were at the time of Lehman Brothers failure and disruption to businesses which followed due to credit seize is unlikely to happen again.

Institute for Supply Management’s index indicates expansion of US Economy

Manufacturing Index

Another leading economic indicator and commonly tracked index suggest that worst is behind past and economy is inching on the path of recovery. It is still uncertain as to how long the economy will take to recover and return to growth rates of the past.

The manufacturing industry was in freefall since September 2008 when the Lehman Brothers bankruptcy occurred leading to credit squeeze. This is reflected in the ISM factory index data for United States in the table below which shows a steep decline in the ISM manufacturing index values beginning September 2008. The ISM factory index dropped to 32.4 in December 2008, the lowest level since June 1980.

Month PMI Month PMI
Jun 2009 44.8 Dec 2008 32.9
May 2009 42.8 Nov 2008 36.6
Apr 2009 40.1 Oct 2008 38.7
Mar 2009 36.3 Sep 2008 43.4
Feb 2009 35.8 Aug 2008 49.3
Jan 2009 35.6 Jul 2008 49.5
Average for 12 months – 40.5
High – 49.5
Low – 32.9


The pace of deterioration has slowed down since January 2009 and gradually started inching upwards reflecting improving prospects for manufacturing industry.

The latest month, June 2009 data indicates that the manufacturing contracted at a slower rate in June as the PMI registered 44.8 percent, which is 2 percentage points higher than the 42.8 percent reported in May. This is the 17th consecutive month of contraction in the manufacturing sector. A reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally contracting.

A PMI in excess of 41.2 percent, over a period of time, generally indicates an expansion of the overall economy. Therefore, the PMI indicates growth for the second consecutive month in the overall economy. Even the average index value of 42.5 for the three months in second quarter indicates that economy is on the rebound. Based on the data above we can infer that the April 2009 might be the last month of recession.

According to Norbert J. Ore, chair of the Institute for Supply Management™ Manufacturing Business Survey Committee, “The past relationship between the PMI and the overall economy indicates that the average PMI for January through June (39.2 percent) corresponds to a 0.6 percent decrease in real gross domestic product (GDP). However, if the PMI for June (44.8 percent) is annualized, it corresponds to a 1.1 percent increase in real GDP annually.

NMI (Non-Manufacturing Index)

Even the ISM non manufacturing index (NMI) for June registered 47 percent, indicating contraction in the non-manufacturing sector at a slower rate compared to May’s reading of 44 percent.

Month NMI Month NMI
Jun 2009 47.0 Dec 2008 40.1
May 2009 44.0 Nov 2008 37.4
Apr 2009 43.7 Oct 2008 44.6
Mar 2009 40.8 Sep 2008 50.0
Feb 2009 41.6 Aug 2008 50.4
Jan 2009 42.9 Jul 2008 49.6
Average for 12 months — 44.3
High — 50.4
Low — 37.4


The manufacturing and non manufacturing data available from ISM suggest that the recovery is underway. But the recovery will be slow and gradual and a robust economy with growth rates of pre recession era will take time to materialize. Housing Sector and Consumer spending are the two critical factors likely to determine the pace of economic recovery.

Factors to Determine Future Direction of US Economy

Housing Sector

US housing sector is a significant contributor to the U.S. economy, providing millions of Americans with jobs and generating hundreds of billions of dollars of economic output each year. The housing sector contributes 12% to 14% to the nation total production.

The stabilization of the financial system and lower interest rates, plus initiatives to support the US housing market, is expected to stabilize the housing sector. Economist and sector analyst are already projecting that the sector has reached bottom, signaling early stages of rebound. The stabilization of US housing sector will have a multiplier effect on the economy. A stabilizing housing sector will impart further stability to the financial sector. Since home equity is an additional source of income and any improvement in home prices is likely to contribute to increase in consumer spending which again is another critical factor for further growth of the economy.

Consumer Spending

Consumer spending is a critical determinant of the direction the economy takes as it accounts for more than 70 percent of the economy. Consumer spending has remained weak through out the recession on account of increasing unemployment and declining home prices. In order to have a sustained and robust recovery, consumer spending needs to grow which is an area of concern since the unemployment is expected to continue to climb and touch 10% even as the economy shows early signs of revival.


The US unemployment rate rose to a 26 year high of 9.5% in June 2009, indicating that economic revival may take longer time than anticipated. The cumulative job losses over the last six months have been greater than for any other half year period since World War II. “This is the only recession since the Great Depression to wipe out all jobs growth from the previous business cycle,” Heidi Shierholz, an economist at the labor-oriented Economic Policy Institute in Washington, said in a research note.

The only bright spot is the declining pace of job losses. From November to March — after the collapse of some prominent financial institutions — the labor market lost an average of 670,000 jobs each month while from April to June, the decline slowed to 436,000 a month. The labor market is going to lag the recovery process to a certain degree. The unemployment will remain high in 2010 leading to constrained consumer spending and a slow recovery.

Emerging Nations to lead Global Recovery

The majority view is that the emerging nations are going to lead the global economic recovery as United States economy show slow progress and European economy still in critical state. China alone may be only 6 percent of the world economy but together with India, Brazil and other big emerging nations, they represent about 30 percent of global GDP. With emerging nations in better shape than their western counterparts, they are expected to pull global economy of current crisis.

China’s economy grew by 7.9 percent in the second quarter of 2009 as the fiscal stimulus package offset the contraction in export activity after reporting 6.1% in the first quarter of 2009. As India, Brazil and other emerging economies also report good GDP numbers the global growth is expected to gain momentum in the days to come.


The worst of economic crisis is behind us and there is cautious optimism for the future. Based on analysis of leading economic indicator we can conclude that the worst US recession since the 1930’s is over with economic recovery on its way.

There won’t be swift economic rebound and a gradual recovery will take place as unemployment rises further and consumer spending remains constrained. The companies cost reductions have helped them to show good quarterly earnings but sales growth is yet to catch up. Companies are going to be reluctant to add investment and jobs until they get better sales.

Additionally there might some short term disruptions on way to a robust growth as the economic situations in Europe remains weak and forex market remains volatile.

Emerging nations leading the global recovery signifies shifting of economic power to these nations. These emerging nations are expected to be driver of global growth in the near future.

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