For the economy to get better people need to pay down excessive debt, which is called deleveraging. This typically takes seven years. The process started with the 2008 crash but has almost stalled out and is proceeding at a very slow pace. The ratio of debt balances to income has grown steadily for several decades. Its growth was reasonable until the over-exuberance of the 1990’s bubble years and continued at unreasonable pace until the Lehman crash of 2008.
To recover from the recession, unemployment needs to come down to the full employment number of 4% unemployment. This will happen through a combination of job seekers accepting pay cuts, moving to places where there is demand for labor and changing careers. The future growth of technology coupled with workers getting retrained for those jobs will be the key to getting out of the recession. To change professional careers it may take two years to choose a new occupation, two years to get ready for the training classes, another two or three years to get the credential, plus more waiting time due to unemployment. So a seven year period maybe needed for job seekers to transition into a more productive career. By coincidence it takes that long for society to go through deleveraging. Perhaps it is not a coincidence, since part of deleveraging may include getting a better career in a new location after having let the old house go into foreclosure.
The crucial mistake made in the Great Depression was that the government tried to prop up wages and prices, which needed to come down in. As long as they were too high then there was insufficient demand. Gradually wages did come down on a “real” basis and the job market reduced unemployment by 15 percentage points.
Today the U.S. is the only major developed country that doesn’t have the anti-business climate and problems of Japan and Europe. There are a huge number of skilled unemployed Europeans who would like to emigrate here. This will push down wages and prices, and will be helped by the U.S. huge supply of cheap natural gas and coal. This will allow the U.S. to take business away from the other developed countries and thus heal our economy.
The challenge that investors face is that the Fed Quantitative Easing (QE) programs have created a stock market bubble, so stock prices are too high to be a stock buyer even with a gradual solution to the recession in sight. Corporate earnings are at a high water mark and could go down. The prudent thing for investors to do is to buy stocks only when the PE10 is below 10 which implies roughly an SP500 of close to the March, 2009 lows of 666 points. The best way to be a stock bull is to first protect your wealth with a temporary investment in bonds and then after a deep crash sell your bonds and buy stocks at good low prices. Stock and real estate bubbles can last for many years and get even bigger. The governments of the world have a conflict of interest because they can’t afford Keynesian deficit stimulus so they hope Central Bank QE programs will magically inflate the economy out of a recession. But all QE does is create misleading stock market bubble that will make people poorer when they make incorrect plans based on bubbles and lose the last of their savings in another stock crash.
There is great danger that the Eurozone could very soon get into deep trouble creating a world stock market crash just at the time the U.S. is facing a huge fiscal cliff at year end. For now investors should maintain a bearish position regarding stocks, commodities, and real estate.