Slouching towards a US recession

Investors may be cheering the decision of US central bank boss Ben Bernanke to keep interest rates close to zero for the next few years, but their enthusiasm is about to be sorely tested by the souring economic outlook.

The US economy looks set to be dragged into recession this year, as exports slump, capital spending slows, and US consumers – who account for around 70 per cent of the economy – are forced to tighten their belts.

Exports – which have been one of the few bright spots in the US economy – are likely to fall this year as the global economy falters. America's major trading partners – Europe and Japan – are already suffering serious economic contractions. At the same time, China and India – which have been the engines of global economic growth in recent years – are also slowing.

Meanwhile, US consumers will be forced to slash their spending. Last year, consumers were able to keep spending despite suffering a fall in their real disposable income because they ran down their savings. But with the savings rate now down to 3.5 per cent, this option is no longer available and consumers will be forced to become more thrifty.

What's more, the lingering problems in the US housing market mean that consumers are still suffering declines in household wealth. Although the US sharemarket posted modest gains last year, most households saw their overall wealth decline because their most important asset – the family home – dropped in value. Figures released overnight showed that in the 12 months to December, the median price of a new house in the United States fell by 12.8 per cent to $210,3000.

And the strain on household finances is likely to get worse, as US state and local governments lift taxes and charges in an effort to bring their bulging deficits under control.

Faced with limp demand, US companies will be reluctant to invest in new equipment and to hire new workers. Indeed, we're likely to see US companies cut back on their investment, now that the special tax concession that allowed them to claim 100 per cent depreciation on their capital spending has expired. Many companies brought forward their spending on capital equipment – such as computers and trucks – so that they could take advantage of this special tax deal. Now that the special tax deal has expired, we're likely to see a sharp decline in capital spending.

And the turmoil in global financial markets is also having an impact on US companies. In recent years, medium-sized companies were able to take advantage of very liquid capital markets to raise cheap funding. But these firms are now locked out of the capital markets, and have to depend on borrowing money from their local commercial banks. As a result, their funding costs have increased, which is causing them to cut back on investment.

A slowdown in the US economy this year is likely to prove particularly painful because US unemployment is already at 8.5 per cent, while the country's industrial production is still below its peak in 2008.

Even worse, policymakers have run out of weapons for boosting the economy. The US central bank already has interest rates close to zero, and expects to keep them there until at least late 2014. And the swollen US budget deficit means that the US government will not be able to resort to the traditional remedy of cranking up spending to provide a quick economic stimulus.