Wednesday, August 16, 2006

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.

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14 Comments:

Anonymous yc said...

There is demand for U.S. products. If we lower the U.S. export restrictions, we can export more.

Wed Aug 16, 10:28:00 PM EDT  
Anonymous Anonymous said...

What exactly do we still make in this country? We cant export houses -- too big to ship.

Wed Aug 16, 10:35:00 PM EDT  
Blogger CalculatedRisk said...

knzn, excellent overview. The last two recessions were short (about 8 months each according to NBER) and mild. If your estimate to the trough is correct (Q1 '08), and the recession starts in Q4 - that would be a more normal duration recession - and it would be very painful.

That fits with my views on the housing market. Although I think the resale housing market will suffer for several years, I expect New Homes Sales to bottom sometime late next year. Growth in construction spending, starting from a much lower level than today, will probably be one of the engines of recovery.

For anonymous, the U.S. is already the World's largest exporter ($120 Billion in Goods and Services last month alone). Of course imports were $185 Billion in July - ouch. Hopefully knzn is correct and oil prices fall during the slowdown. That will definitely help with the trade deficit.

Best Wishes.

Thu Aug 17, 01:32:00 AM EDT  
Anonymous save_the_rustbelt said...

You mean the Bush tax cuts didn't save the economy. Gosh.

The next recession is going to be a bloodbath. Look for 20% of all American manufacturing jobs to be permenantly destroyed.

Thu Aug 17, 11:52:00 AM EDT  
Anonymous yc said...

anonymous at 10:35,

I may be wrong but I observed that our comparative advantage leans to the service sector. The fact that we have trade surplus in service sector may be a reflection of the theory.

For example, we have comparative advantage in higher education and travel. If our government issues more visa to foreign students and tourists, it would help to reduce trade deficits. Of course this is only a drop of water comparing to the ocean of real problems.

You mentioned houses are too big to ship. My thought is, if we DO have comparative advantage in the housing sector (though we don't), there WILL be a way to export our houses. Say if every house that you export to Mexico will bring to you $1 million profit. What would you do? Do you still think houses are too big to ship? Will you think of a way to get that profit?

Thu Aug 17, 12:44:00 PM EDT  
Blogger knzn said...

I do still think that the Bush tax cuts helped with the recovery. Consider that the savings rate out of disposable income is already negative. Imagine how much more negative it would have to be to get the same consumption (hence the same demand) if there were more taxes being taken out. I also think tax cuts made sense as insurance, because at the time, we couldn’t be confident that the Fed’s stimulus was sufficient to produce a recovery.

As for the coming hard landing (if it is coming), despite the timing discussed in the post, I would not necessarily expect a long recession, because the Fed’s subsequent actions will also affect the outcome, and also because the economy may slow moderately first and then go into recession later. The last two recessions have been relatively short, but in both cases, there has been an overhang of “jobless recovery” that lasted for a couple of years. I expect the pattern in the subsequent cycle may be similar.

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