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Wednesday, January 22, 2003

The Uncertain Future of the American Economy

This week it's the Economist's turn to muse over the divergent data that we keep getting for the US economy. The problem is that for each piece of good news, there seem to be two pieces of bad. As long as this ratio is maintained the downside risks only grow. First there is the news that housing starts were strongly up in December. Statistics released on January 21st and which measure new-house construction, show the level of new starts was at it's highest since mid-1986. Good news, well yes, but always bear in mind that consumption is being disproportionately driven by housing values, either through refinancing or new starts, and that this in turn is being driven by ultra-low interest rates and a higher than average rate of inflation in the property sector, which makes property an interesting assett to hold, especially when the equity market is down and out. One day or another this will come to an end, since long term growth in property prices cannot move much out of line with earnings growth. But then we had the news that fourth quarter GDP hardly moved, and may even have contracted. In addition there was December's unexpectedly large job fall-out, together with the record trade deficit, and to cap it all we discovered that US retail prices only rose 1.2% year on year to December, dead on target to enter negative values (deflation) in 12 to 18 months if all this doesn't turn itself round:

Monthly data are often unreliable, of course; there is always a plausible explanation for unexpectedly bad (or good) news. The November trade gap, for instance, reflected a big surge in imports following President George Bush’s action to halt the dockers’ strike on the country’s west coast. But nearly all recent economic statistics point to the same conclusion—that America’s recovery remains sluggish and erratic. The data on housing starts do not fundamentally alter this gloomy diagnosis. Ironically, this is likely to help Mr Bush garner political support for his latest stimulus package, unveiled on January 7th. It could also put pressure on the Fed to consider cutting interest rates again when its policymaking committee meets at the end of the month.

The biggest obstacle to healthier economic performance, though, is political. As the Fed’s chairman, Alan Greenspan, acknowledged in the closing months of 2002, uncertainty about the future is holding both investors and consumers back. The shadowy threat of international terrorism and the much more explicit prospect of a war with Iraq has made many Americans nervous about the future. For businesses still reeling from the speed at which the late-1990s boom turned to bust, the political climate is one more reason to put off investing in new plant and equipment or hiring new staff. For consumers, for so long the mainstay of the American economy, the thrill of the shopping mall seems, finally, to be on the wane. On January 17th, the respected University of Michigan survey of consumer sentiment showed an unexpected drop because of gloomier expectations of future spending.
Source: The Economist

All of which has prompted the NBER's business cycle dating committee to withold judgement on whether the US recession is officially over:

According to the most recent data, the U.S. economy continues to experience growth in output but declines in employment. Real personal income has generally been growing over the past year, while employment fell significantly in both November and December 2002. Recent data confirm our earlier conclusion that additional time is needed to be confident about the interpretation of the movements of the economy last year and this year. The NBER's Business Cycle Dating Committee will determine the date of a trough in activity when it concludes that a hypothetical subsequent downturn would be a separate recession, not a continuation of the past one. The trough date will mark the end of the recession. The committee will not issue any judgment about whether the economy has reached a trough until it makes its formal decision on this point. The committee waits for many months after an apparent trough to make its decision, because of data revisions and the possibility that the contraction would resume. For example, the committee waited until December 1992 to announce that a trough had occurred in March 1991.
Source: National Bureau of Economic Research

While the NBER is still trying to decide whether any return of clear recessionary indications would mean we have a prologation of the first one, or the start of a second, Morgan Stanley's Steven Roach continues to claim the arrival of the double-dip. This is a secenario wherby a demand relapse early in a recovery plunges the economy back into recession. He argues that the double dip, far from the exception, has actually been the norm in America’s recessionary experience over the past 50 years. More often that not, demand relapses have occurred just after businesses had started lifting production and rebuilding stocks. That then requires another round of output, employment, and inventory adjustments -- the second dip. In fact, he says, in five of the preceding six recessions, there was a brief interval of positive growth -- the false recovery -- that then gave way to a climactic end-of-cycle downturn, and in two of those recessions -- those of the mid-1970s and early 1980s -- there were actually not double, but triple dips. And why does he think this is happening this time round? His answer is clear: such double dips are the classic by-products of a post-bubble US business cycle. Until, he suggests, America faces up to a purging of the excesses that built up during its late-ninetees bubble, the threat of another dip remains an ever-present possibility. Unfortunately, he has a long list of such excesses -- in particular record levels of consumer indebtedness, record lows of net national saving, and a record balance-of-payments deficit. Seeing the problem isn't too hard, the trick might be in finding out how to 'purge' these excesses without sending the US hurtling down into a major depression. Raising saving and reducing indebtedness, remember, will only serve to reduce aggregate demand further absent large-scale investment hikes, but were would those investment hikes come from in an economy which already has excess capacity and where consumer demand would be falling?

It has been a year since I first came out of the closet as a double-dipper (see my 6 January 2002 dispatch, "Double-Dip Alert"). While the outcome hasn’t transpired in precise conformity with my script, the dreaded dip has been far closer to the mark than a classic cyclical recovery. And now we’re face-to-face with yet another dip alert. This is a continuation of the seesaw pattern that has been evident ever since the US economy officially stopped contracting in late 2001. The wild and frequent swings from near boom to near bust have been the rule, not the exception over the past year. The economy surged at a 5% annual rate in the first period only to sag back to an anemic 1.3% pace in the second. Then it was back up to a 4.0% clip in the third quarter before coming to a screeching standstill in the final period of the year. Morgan Stanley’s GDP "tracking model" -- which filters the GDP content of all the high-frequency data on retail sales, capital goods shipments, construction activity, exports and imports, and government spending -- is now flashing "zero growth" for 4Q02. It’s not a strict dip -- as a purist I insist on a negative sign -- but you can’t get any closer. Experience underscores the whimsy of national statistics. With a central estimate of "zero," the actual number could just as easily be in negative or positive territory. But no matter which direction government statisticians divine, the quarterly change for the period just ended now appears to have been very small. And that’s the basic point.

There is an important message to be taken from a US economy that is now back on the brink of a recessionary relapse. The repeated risks of a double dip have not come out of thin air. They are classic by-products of a post-bubble US business cycle. Until America faces up to a purging of the excesses that built up during the bubble, the threat of another dip remains an ever-present possibility. Unfortunately, there is a long list of such excesses -- namely record levels of consumer indebtedness, record lows of net national saving, and a record balance-of-payments deficit. I stress the word "record" in describing each of these attributes of a US economy that has gone to excess. It indicates how far out on a limb America remains in clinging to a growth rate it can no longer sustain. In the end, that’s what the bubble was all about -- the ultimate temptation for the world’s dominant economy to indulge in a lifestyle it could not afford. We all took a bite out of the same apple. There is no easy or painless cure for this post-bubble hangover. Lingering structural imbalances are the functional equivalent of stiff economic headwinds that have the potential to constrain the US economy to a subpar growth trajectory. With a US-centric global economy lacking any other engine of autonomous growth, a dip-prone America puts the world in a similar predicament. That’s certainly the message from near-recession-like conditions that are once again evident in Europe and Japan.
Source: Morgan Stanley Global Economic Forum

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