FORTUNE — Throughout the U.S. recovery we’ve seen economic data bounce in peaked highs and lows. Real GDP growth since the financial crisis has been as high as nearly 5% year over year and as low as 0%. I expect the sluggish and volatile recovery to continue for years to come. Why? In one word: deleveraging.
The U.S. economy has been going through a deleveraging not seen since the Great Depression. Back then, total debt reached 300% of GDP. It continued to drop over the next two decades to 150% of GDP before rising again in the early 1950s.
The deleveraging of the Great Depression was accomplished thanks to a combination of household austerity, inflation, and government stimulus. Household austerity occurred thanks to elevated savings rates along with pay-downs and defaults on debt during the 1930s while rationing to support the war effort had similar effects in the 1940s. Additionally, breaking away from the gold standard helped raise prices and therefore reduced the real value of America’s debt. Lastly, the government spending from various New Deal schemes to the vast mobilization during WWII contributed to keeping total GDP growth positive.
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The deleveraging that we are going through today is much improved from the volatile economic outcomes experienced during the Depression. Most of the deleveraging since the Great Recession has occurred in households, mostly in the form of mortgages (which fell from 73% of GDP in 2008 to 55% of GDP today), and across the U.S. financial sector (where debtfell from 118% of GDP in 2008 to 82% of GDP today).
Conversely, the federal government leveraged up (with debts rising from 72% of GDP in 2008 to 102% of GDP today) to offset this decline in borrowing from households and the financial sector. The other major sources of debt (non-financial corporate, state & local government, consumer credit, and foreign borrowing) have remained largely unchanged from crisis levels. So overall, the decline in debt-to-GDP has been relatively muted so far, falling from 409% of GDP in 2008 to 392% of GDP today.
Nonetheless, the U.S. has experienced better outcomes, especially when compared to Europe and Japan because it is keeping the combination of austerity, inflation, and defaults as balanced as possible, while keeping nominal GDP growth above the general interest rates in the economy. The fact that nominal GDP growth is greater than average interest rates is a prerequisite for a well-handled deleveraging, and it is one reason why U.S. economic performance, while choppy, has outperformed many of its industrialized peers.
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Europe, for example, has seen its GDP growth contract in recent years while in many cases the benchmark lending rates exploded higher. This has resulted in debt-to-GDP ratios actually continuing to climb since 2008 in much of the Euro area. Japan has also seen its debt-to-GDP ratios climb consistently since the early 1990s despite having the lowest interest rates in the developed world. This has occurred because deflation has kept nominal GDP growth below even their extremely low interest rates.
Europe’s poor economic results have occurred thanks in part to a disjointed relationship between monetary and fiscal policy. The Maastricht Treaty puts limits on federal budget deficits in Europe while the absence of a unified treasury makes monetary policy (QE policies in particular) difficult to administer. Let’s hope for their sake (and ours) that they follow through with their recent statements about being more accommodative if necessary.
Japan has also gotten its policy responses incorrect following their debt build-up and financial crisis. While Japan had the same monetary and fiscal policy tools as the U.S. government (but not the Europeans), they generally lacked a sense of urgency to their policy responses in the early years after their crisis in the early 1990s. Japan’s government, in error, delivered policies as if its economy was in a typical business cycle slump. After years of languishing with sub-par growth, “Abenomics,” Prime Minister Shinzo Abe’s three-pronged approach to jump-starting the economy, could represent a turning point for Japan’s economy. Time will tell if these bold policies will restore consistent growth and ultimately push nominal GDP growth above their interest rates.
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So should we just ignore the economic data? Of course not. Just be prepared for continued economic reports that don’t look that bad or that great. Don’t get worked up over one month or one quarter of soft data. The environment we are going through today is unlike the business cycles that most of us have grown familiar with over our careers. While robust growth is unlikely to materialize in the near future, we can be confident that a policy-driven recession is also unlikely to occur. Absent some external shock, we are likely to continue to muddle through for the next several years. Be thankful that our policymakers, especially at the Federal Reserve, have accurately diagnosed the patient and are doing their best to accommodate this deleveraging process.
“Monty J. Bennett is Chairman and CEO of Dallas-Based Ashford Hospitality Trust and Ashford Hospitality Prime, as well as CIO of Ashford Investment Management, a real estate focused investment management company.” Follow him @MBennettAshford
