Five risks to a US recovery

As the US makes tenuous steps towards sustainable growth, there are five areas which threaten to instigate a recession despite the US private sector proving remarkably resilient.

The US economy grew at 3 per cent annual rate in the fourth quarter, but first half growth is likely to disappoint, renewing upward pressures on unemployment.

Fourth quarter growth was powered by stronger consumer spending – especially on autos, substantial additions to business inventories, and stronger multi-family home construction.

Through most of 2011 gains in consumer spending outpaced incomes; however, from November through January, real consumer spending was flat. In recent months, higher gas prices absorbed significant additions to nominal income created by a somewhat stronger labour market.

Unlike the boom years of the last decade, households will not be able to refinance credit card debt by further mortgaging homes, and consumers simply had to slow down. The notable exception continues to be autos, where an aging fleet helps increase sales, and higher education – much of the recent surge in consumer credit has not been on credit cards but loans to finance autos and higher education.

Forecasts

The economy will register growth at or below 2 per cent the first half of 2012, perhaps picking up the second half of the year to about 2.5 per cent, and tail back to about 2 per cent in 2013.

Quarterly Forecasts (per cent)
Q411
Q112
Q212
Q312
Q412
2111
2012
2013
    GDP: Annual
3.0
1.5
1.5
2.6
2.5
1.7
2.0
2.1
    GDP: Q4/Q4
1.6
2.0
2.0
    CPI: Y/Y
3.3
2.7
2.3
2.1
2.5
3.1
2.4
2.6
    Core CPI: Y/Y
2.2
2.2
2.1
1.9
1.9
1.7
2.0
1.8
    Unemployment
8.7
8.3
8.4
8.5
8.6
8.4
8.8
8.9
    Federal Funds
0.125
0.125
0.125
0.125
0.125
0.125
0.125
0.125


Bright spots include continuing strength in autos and a modest recovery in residential construction – which is already underway; however, worries that existing home prices may fall further, and difficulties reselling homes could limit mobility in a still tough labour market, are pushing more young families into renting.

The costs imposed on regional banks by tighter regulations for residential mortgages, and the greater concentration of deposits among large Wall Street banks – thanks to industry consolidation prompted by Dodd-Frank – make financing more easily available for multi-unit developments. Much of the recovery in residential construction has been concentrated in apartment buildings.

Recent industry and government reports indicate some recovery in home prices from 2011; however, those are from quite depressed levels. Overall, housing values are not likely to improve dramatically, and may fall further on a seasonally adjusted basis this spring and fall, owing to slower GDP and employment growth.

Industrial production and manufacturing will continue to expand but jobs creation in those sectors continues slow. Simply, the failure to address currency issues with China and others, and rising protectionism in China, Brazil and others in their orbits make manufacturing using significant amounts of labour tough in the United States. Most of the gains will be in resource related sectors – e.g., oil and gas equipment – and high-tech and other durables, using minimal production labour.

Risks to recovery

Adverse events in any one of five areas could instigate a recession.

1. China faces real challenges – falling property, questionable accounting standards and banks stuffed with bad loans. Once again, China is turning to protectionism – increasing tariffs and suppressing the value of its currency to keep out US exports. The Administration has shown little inclination to confront these aggressive practices other than through piecemeal WTO complaints, which in total do not yield the systemic improvements necessary to correct trade with China. Moreover, House Speaker John Boehner appears to share President Obama’s predispositions on trade issues with China making unlikely any action until after the fall elections, if then.

2. Most major US banks are healing, as witnessed by the Fed’s recent stress tests. Even Citibank is likely in better shape than the Fed estimated – it overweighted the risks associated with Citibank’s large overseas loan portfolio, and failed to recognise the value of international diversification. The securitisation market is showing some life, and regional and small banks are realigning around business lending as new federal regulations make conventional home mortgages too difficult to write.

After buying up smaller banks that can't cope with new, tougher regulations, Wall Street banks control more than 60 per cent of deposits nationally, and are driving down certificate of deposit rates (essentially exploiting monopoly positions as they acquire banks in regional markets). Seniors are losing a lot of purchasing power, and Wall Street banks are less interested in making loans to Main Street businesses than were the regional banks they absorbed.

Instead of using their new girth of deposits to finance small and medium sized businesses, Wall Street banks are engaging in other, non-traditional-banking activities that don't move the economy forward. Gaming at the Wall Street casino tables pays the big bonuses, while the old fashioned business of making loans from government insured deposits does not.

3. Oil prices appear to have plateaued, and the Obama Administration, its election year rhetoric notwithstanding, continues to stall, slow and stop US oil and gas projects at every turn. That affects the economy much like a negative stimulus package – petroleum projects use the same kinds of stuff (steel, cement, construction workers) as building roads and buildings.

4. The European Union is in recession and remains in deep trouble – fixes for Greece, Portugal and Ireland are inadequate and eventually will need to be reworked. The right steps were not taken, and the crisis has not passed. Fixes for Greece, Portugal and Greece were ill-conceived and inadequate, and will have to be reworked.

European economic powers – in particular, Germany and France – appear wholly disinclined toward forging a genuine fiscal union – towards continental taxation to finance essential functions of government. Limits on national deficits are no substitute for common taxation and unified spending policies, and instead such austerity almost guarantees a difficult European recession, and painful trade-offs between price deflation and even more unemployment among the Club Med States.

5. Higher education loans are a ticking bomb. Undergraduates are borrowing too much against future incomes, and many graduate students are borrowing to obtain degrees that will not markedly improve their circumstances.

Administration efforts to get more young people into school lowers the unemployment rate in the short run, but without fixing the trade deficits on oil and with China, accomplishing credit market reforms, and improvements in Europe, enough decent paying jobs will not be available for many new graduates.

Most education loans are not dischargeable through bankruptcy, and big debt coupled with disappointing pay will become an increasing drag on consumer spending for the next decade.

In the face of all this, the US private sector is proving remarkably resilient. Neither policy missteps in Washington nor purposeful incompetence in Europe can keep American capitalism down. However, it would a darn sight better with better government leadership on both sides of the pond.

Peter Morici is a economist and professor at the University of Maryland School, and former chief economist at the US International Trade Commission.

@pmorici1