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November 28, 2005
The Case for a Long and Deep Recession
Paul Ashworth, senior international economist at Capital Economics Ltd in London, has written a new report, titled "The coming US recession" which lays out the case for a long and deep downturn in the U.S. I'm not sure I believe it, but he makes some interesting points
We are becoming increasingly concerned that even a soft landing for the US housing market, with prices leveling out, will push the economy into recession sometime in the next couple of years. Admittedly, this timing is speculative and the probability is still no more than 30%. However, the risks are high enough that clients should, at the very least, be seriously considering such a scenario. The low risk premiums implicit in most asset prices suggest markets certainly aren’t giving the possibility of a recession enough weight.
We don’t pretend to be able to pin down the timing of this slowdown, but we can say something about its central characteristics. The downturn will be concentrated in residential investment and consumption, and the housing market will be the key.
Residential investment may need to fall by as much as 25% to return it to more normal levels relative to the rest of the economy. As households’ capital gains from real estate dry up, their spending may remain unchanged for a couple of years, or even decline, while the savings rate rebounds from the current negative rate to between 5% and 7%. Up to 2m jobs could be lost in the housing-related and retail sectors. Overall, the unemployment rate would be likely to breach 7%.
Talking to Ashworth by phone, he suggests that early 2007 might be the right timing for a recession.
Here's more from the report:
Predicting the timing of recessions is a fool’s game
Of course, pinning down the timing of turning points in the business cycle is notoriously difficult for forecasters. Indeed, the NBER, the arbitrators of the US business cycle, often can’t reach firm conclusions on the timing of peaks and troughs in the cycle until years after the fact, let alone beforehand.
We are not even going to pretend that we can accurately predict when the next recession will occur. Let’s be honest, we are not even sure there will be a recession in the next few years. Much of what follows in this Focus is highly speculative.
But the risk has become big enough that we feel clients should at least be thinking about what strategies to adopt if the worst happens. The low risk premiums implicit in most asset prices suggests markets certainly aren’t giving the possibility enough thought.
To those ends, the rest of this Focus will concentrate on what we expect to be the central characteristics of that recession and what early warning signs we expect to see in the run up to it.
The shape and form of the next recession
It is now becoming clear to us that the next recession will be concentrated in consumption and residential investment. The key will be the housing market. In all likelihood, it will be a long and deep recession. Indeed, it will need to be a long and deep recession to purge the US current account deficit and rebuild households’ balance sheets.
But Ashworth is actually optimistic about the U.S. in the long run.
Despite our short-term pessimism about the US economy, we cannot stress enough how bullish we are about the outlook beyond the next difficult period.
We expect strong productivity growth to allow the US economy to grow at 3.5% per year or higher for a decade or so uninterrupted. The economy should be firing on all cylinders – both firms and households will have strong balance sheets and a low dollar should mean a buoyant export sector in the first few years. The US has the advantages of flexible labour markets, well-developed capital markets, large human capital and relatively positive demographic tren
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The housing bubble will seriously hit the net worth of many middle-class people in certain high-risk areas.
Whether this is enough to cause a recession is debatable, as groups that will *not* be hit by this are :
1) Americans not living in CA, NV, AZ, FL, or MA (the remaining 75% of the US population)
2) Americans too poor to have bought a house in the first place, or too young to have reached the house-buying phase of life yet
3) The tech industry. After what they went through in 2001-04, tech companies are so lean, productive, and cautious that very little could detail them at this point in time. With many new innovations on the brink of market arrival, they would actually be the bulwark of the economy by 2007.
So it remains to be seen if the downward forces from the localized housing bubbles are enough to bring down the whole economy, particularly for a long recession, rather than just a short one.
Posted by: Kartik at November 28, 2005 01:28 PM
If productivity grows at an amazing 3.5% a year over the long term, that certainly solves a vast myriad of other problems, doesn't it?
That may be the most impactful sentence of Ashworth's whole article.
Posted by: Kartik at November 28, 2005 01:37 PM
What is your take on the macro economy in the short term ?
Also do you have a link for Ashworth's artcile pls ?
Posted by: Navin at November 29, 2005 06:12 AM
This ordinary people of this country can only survive by intermittent bubbles of some sort.Saving is an impossibility and foolish in the long run .The degradation of the currency (the USD) bails the govt. out of its debt as well.
Stagflation is here I think.
Posted by: Tariq Siddiqui at July 30, 2006 09:29 PM
In Austin, we have a big housing boom. Do you think that it will be one of the affected regions in the U.S. despite it's dynamic workforce?
Posted by: Vincent Lyons at October 4, 2006 03:17 PM