Catch Me Now I’m Falling

(This is Captain America calling...)

Only export demand can save the US from a hard landing.

The recent recovery appears to have been primarily a result of the Fed’s easy money policy of 2002-2003, which appears to have been effective primarily by means of its effect on the housing market. The Fed began to remove accommodation at the end of the second quarter of 2004. The housing market peaked in the fourth quarter of 2005 and is now showing dramatic signs of weakness. The recovery began to wind down in the second quarter of 2006, as evidenced by the string of weak payroll employment statistics that began in April and stood in stark contrast to the first quarter’s numbers. This pattern suggests a long lag – about 21 months – between monetary policy actions and effects during the current cycle. If the timing is similar on the way down, then we should expect a trough in the first quarter of 2008 – and if the US economy continues to weaken between now and then, it will be a long way down.

The downturn in housing affects construction and consumer spending. If we’re very lucky, the price of oil will go down and offset some or all of the effect on consumer spending, but with the personal savings rate currently already negative, there is little reason to hope for consumers to continue leading a recovery even if oil prices do decline. Nor is there evidence of a domestic investment boom riding in on a white horse, despite the tremendous amount of cash that corporations now have available. Such a boom, if it materializes, will have to be motivated by some expectation of demand. That demand won’t come from consumers. It won’t come from government, which is in deficit-cutting mode and already winding down its role in rebuilding last year’s hurricane damage. If the demand comes, it will come from exports.