- I think that the US economy is likely to improve a bit in the second half (absent new and unforeseen shocks). I think the slowdown in the last few month's data was primarily a function of the high energy prices in the spring. Those in turn were caused by turmoil in the Arab world and actual loss of Libyan production. I expect global oil production will resume growing now (perhaps slowly and fitfully) at least for a bit.
- I think the Republican ploy over the debt limit has probably caused a significant hit to confidence and aggregate demand in July/August. However, people will forget after a short while. The actual agreement seems to be only very mildly contractionary in the near term and in the medium and long term it is all subject to renegotiation anyway. There's probably some lasting damage to investor confidence that might cause some relative shifts in the prices of different asset classes but not have a big impact on the real economy.
- The US fiscal picture continues to be very unsustainable in the medium term, but I don't think we are close enough to the edge of the precipice for it to cause serious economic damage this year or next.
- Large US banks seem broadly sound.
- In the absence of specific reasons to contract, the economy will tend to revert to its natural tendency given enough resources - to grow. I would be surprised to see an out-and-out recession in the US now.
- However, I think the US recovery will continue to be basically jobless as companies continue to invest in more technology as a substitute for hiring. I don't expect to see much if any improvement in the employment/population ratios. I don't expect the highly polarized political system to be able to come up with anything that has any impact on this.
- Europe still seems to be in a world of trouble to me. Now that Spain and Italy have lost bond market confidence to the degree that they have, I don't see how this can get better without getting a lot worse first. It's going to take heroic efforts to avoid a complete break-up of the Eurozone, and the current political leadership has certainly not shown any sign of the necessary courage and ability - at every stage, they've shown an uncanny knack for doing too little, too late. It's hard to see how the worsening crisis doesn't eventually lead to an outright Eurozone recession.
- The implications for the rest of the world are complex, however. A loss of European demand will tend to be a drag on other economies. On the other hand, in a resource constrained world it may tend to moderate resource prices (particularly oil) and in turn allow a little more room for everyone else to grow before triggering the next energy price shock.
Your thoughts welcome in comments...
12 comments:
I'm afraid that continued spending reductions forced on state and local governments by reduced tax receipts will cause a spiral of more contraction in both the short and medium turn. That will keep the economy on the edge of a recession for quite a while.
The main risks from the European front as I understand are not in the demand front (although this would be significant), but rather (1) sovereign default risk (2) financial sector stability. Sovereign default is especially worrying as this could lead to a seize-up of bonds market. Calculated Risk had a series of guest posts on nightmare scenarios of default, and these included Japan (which, in many ways, is not that different from Italy in its low growth / high debt / ageing population indicators, as many have commented).
So while I would not risk giving a forecast, the potential for a Lehman Brothers- event is not insignificant. The Guardian's Larry Eliott actually suggested it could be worse this time.
" I think the slowdown in the last few month's data was primarily a function of the high energy prices in the spring. Those in turn were caused by turmoil in the Arab world and actual loss of Libyan production. I expect global oil production will resume growing now (perhaps slowly and fitfully) at least for a bit."
Talk about self persuasion ...
Stuart, this is almost exactly what I've been saying to people recently - especially about how a Eurozone panic might be the only thing that will bring energy prices down enough to give us some breathing room. The only part I'm a bit unsure about in your discussion is the notion that US banks are broadly sound. I've seen some analyses of the huge derivative exposure JPM has. Not sure if that would manifest as a problem or not.
I am quite worried about our political system, which would spill over into declining economic performance. The debt fight, and the FAA fight, indicates that we are in a Hitler-Chekoslovakia situation. One side is intransigent in its extreme and damaging demands. The other side appeases step by step by step, till it loses the political support of its own side, and is regarded as fatally weak by everyone on all sides.
The end result is a far more profound gridlock / shutdown if the appeasement ends at some point, or even some kind of pitched battle / civil war, the nature of which I can not really divine.. rich + tea party south and poor vs the left middle class. It is an ironic situation for a "uniter" to lead us into.
I have trouble figuring out what drives meaningful growth. Consumption is 60-70% of GDP (depending on your definition) and I don't see any drivers for consumption other than population.
Wage/labor pressure is all down. Real-estate price pressure is flat to down. The ability to take on more debt is still severely limited. For the vast majority of consumers, those three things represent 90% plus of their potential spending sources. Sure, the very well off my ride increases in other assets to some marginal additional spending. But how big an impact can that really have? Seriously, the wealthy are already buying all the stuff they need. How much more will they buy with the next million $? And what would they buy, anyway? Financial instruments? These may create GDP, but they won't create much in the way of jobs. And I'm not holding my breath for the flood of trickle-down investing in American, boots-on-the-ground, business.
Eventually, the double-edged sword of increasing population will eat away at the gross consumption numbers, resulting in increasing GDP. But, the corresponding increase in available labor will act to keep wages depressed, and the corresponding increased demand for services will keep non-discretionary expenses high. This seems a recipe for gross growth, but per capita stagnation or decline.
Beyond population, from where will meaningful growth come?
Bmerson - the main driver of growth is technological change that drives productivity increases.
I also think that Europe is in a world of trouble. Spain and Italy constitute 40% of the GDP of the Eurozone, so I think the markets see Italy as the tipping point. If Italy needs a bailout, then 40% of those who are supposed to do the bailing out themselves need to be bailed out. I think the markets correctly perceive this as not viable.
The EMU needs to break up but no European politician is allowed to come out and say it. They have to let the markets do the dirty work so they can shrug their shoulders and say "we tried".
As for how ugly the breakup will be - I think it might be quite ugly. Germany and France are seen as the strong members of the Eurozone but I understand their debt to GDP ratios stand at about 80%. After they are done bailing out their banks (because there are a lot of banks that are going to get slammed when the PiiGS start defaulting on their sovereign debt), their debt to GDP is going to be well into crisis territory. And who will be the "lender of last resort" when the liquidity dries up? The rumours I am hearing is that the FED are saying it won't be them, and the ECB will be a dead duck in a fragmenting Europe. Nobody else has deep enough pockets - which implies to me the possibility of a banking crisis unlike any we have seen since the 1930s.
Stuart,
You seem to be saying there is additional oil production available to support increased OECD oil consumption. With Chindia increasing their consumption, the OECD is being forced to consume less through higher prices. This dampens consumer enthusiasm and prevents meaningful economic growth. I expect a Eurozone financial crisis to flare once the summer holidays are over, and this will further chill confidence, dampening demand for oil in the OECD.
Are we seeing the increase in fuel efficiency speculated about for the "Auto Efficiency Wedge" to enable continued economic growth? I have not seen it. Are we seeing meaningful increases in world oil production capacity (including Iraq)? Again, this is not apparent. In this context I see a decade of economic fits and starts with continued growth in public sector debt in the OECD.
If Italy and Spain cannot be bailed out then my first guess would be that all the PIIGS end up falling out of the euro in a more-or-less Argentina-like banking crisis. They devalue the new iEuro, sEuro, pEuro, etc and begin the long road back to recovery. Meanwhile if the core of the Eurozone can hold together then they can perform a Swedish style nationalize/recapitalize/privatize cycle on their banks with the ECB still being able to issue Euros and provide a liquidity backstop. The euro will no doubt fall a lot with all the uncertainty and this will help exporters and begin the recovery process.
Of course it all depends on the quality and judgement of the core country leaders...
Stuart. I think you are right that the ultimate outcome in Europe is for a two stage core/periphery economic structure to emerge. And is this such a bad thing? You can still have PIGS within the EU but not in the euro bloc. The EU was founded as a political union post WW2 to reduce the potential of future conflict and in this area it has been extremely successful. If it keeps that role, all is not lost.
The key question though is whether the stresses and strains that may cause the PIGS to pop out of the euro are the result of micro rigidities (inflexible labour markets, over-regulation and so on) or more macro-level productivity slowdowns. As you say, ultimately GDP growth is driven by productivity gains. The two (micro and macro) overlap, but a large chunk of the productivity gains come through the advancement of technology, which economists treat as 'manna from heaven'.
Wrigley's book "Energy and the English Industrial Revolution" that you referred to recently highlights the fact that this 'manna from heaven' was actually premised on fossil fuels. The Newcomen steam engine was a technological advance that allowed England to exploit deep mine coal for the first time, but without that deep coal being there you couldn't have powered the Newcomen steam engine. And in turn James Watt's superior design would never have seen the light of day.
It intrigues me that Brent oil is staying stubbornly high despite the bad economic numbers coming out of Japan, Europe and the US. Presumably this is due to growth economies like China outbidding none growth economies for each marginal barrel of oil.
My fear then for the PIGS is that they then may face two adjustments. One is a currency adjustment as they leave the core euro—the type of adjustment that we have seen with Sweden and a whole host of other countries in the past—and the second is an energy/technology adjustment.
For example, the PIGS are principally service economies and have benefitted from the explosion of short-haul flights. The short-haul airline industry— popularised by easyJet and Ryanair—in turn is partially a product of soft technologies like the application of seat occupancy and pricing algorithms. Such algorithms are the result of advancements in computing and math that have arrived like 'manna from heaven'. Because of such advances in technology, you now have European industries built around UK stag and hen nights in Tallinn in Estonia and winter homes for Scandinavian retirees in the Algarve.
If we assume that these airline optimisation algorithms are mature technologies, then there will come a point where all these short-haul flight industries suddenly are rendered obsolete or severely impaired if jet fuel prices remain elevated or keep rising. The point is that you can't apply the technology of flight optimisation without access to cheap jet fuel. So once the price of jet fuel rises, you get a double hit. One is the direct one of the fuel price rise biting into incomes, but the second one is the degradation of an existing technology: the manna from heaven starts to be taken off the table (and this is why I think anyone who invests in vacation property based on short-haul mass market flights is absolutely nuts). It is as if Necomen's steam engine suddenly has restricted access to deep mine coal.
The implications for not only the PIGS but also the US, UK and Japan are bad, since rising energy prices have the potential to not only blunt growth but actually undermine it. The economy becomes much more unstable, and the hit from rising oil prices thus has the potential to actually shrink output before you get back to equilibrium.
Separately, if you want a refresher on Japan's debt situation, Spike Japan has just done an excellent one here:
http://spikejapan.wordpress.com/2011/07/17/japan-how-bad-is-the-fiscal-mess/
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