U.S. Economy Braces for Soft Target

JUNE 11, 2011   THE WALL STREET JOURNAL

By KELLY EVANS

These "soft patches" are no accident, and external shocks are not entirely to blame. The U.S. economy is just laboring under the weight of its own debt.

The recent stretch of disappointing economic reports has put the nail in the coffin of those holding out for a "normal" U.S. recovery. From the double-dip in housing to the meager 1.8% first-quarter growth rate to the nation's high and rising unemployment rate, signs of malaise are undeniable. Goldman Sachs, which started the year with a 3.4% economic growth forecast—among the highest on Wall Street—recently admitted to being "puzzled" by the weakness.

After all, many of the factors which made that firm and others bullish on 2011—the payroll tax cut, the Federal Reserve's loose-money policy and improving financial conditions—are still in place. Moreover, Goldman's 3.4% growth forecast was already conservative by historical standards, to account for the anemic behavior of recoveries that follow financial crises. Apparently, it just wasn't weak enough.

Trouble is, a 2% growth rate for the U.S. is a very different thing from a 4% or even 3% one. It means assumptions for everything from closing the budget deficit to funding pension obligations are too rosy. It means unemployment is likely to remain stubbornly high. And it also means that further bouts of recession will be tougher to avoid—which will only compound these structural problems.

Yet, while there will be stronger quarters, this 2% reality is probably here to stay for a while. The fundamental problem for the U.S. economy today is a lack of demand, precisely because so much of it was pulled forward during the credit and housing bubble. Need proof? Check out the sinking yield on the 10-year Treasury note, which is struggling to stay above 3%. If that seems low, consider that yields on Japan's 10-year note hit a low of 0.4% in 2003—more than a decade after its own asset bubble popped.

This discouraging reality also illustrates why the Federal Reserve's aggressive monetary policy is mistimed. It would have been far more beneficial for policy makers to keep household debts from soaring in the first place than to try now to support asset prices like housing. Indeed, the Fed's latest quantitative easing efforts failed to stem the drop in home prices, instead giving stocks and commodity prices a lift—with the benefit skewed to the richest Americans.

The central bank cannot create a new generation of willing home-buyers. In fact, the current generation is more likely to eschew home-buying altogether. So there is no magic lever to bail out households stuck with massive mortgage debts. The process of repairing household balance sheets will simply take time. In the meantime, the U.S. should consider itself lucky if 2% growth is as bad as it gets.

Write to Kelly Evans at kelly.evans@wsj.com