The Daily Cow

A year ago I argued that recession in the United States (at least by the technical definition of two consecutive quarters of economic contraction) was not likely given the macroeconomic figures being published. But I made that prediction based on my anticipation of strong export-led economic growth.

Yet things have changed, specifically in the currency markets, international financial markets, economic growth abroad, and socio-demographic changes worldwide, and like the exceptional economist that I pretend to be, I am compelled to revise my original assessment:

1. Currency market: Since I've last written about the prospects of a national recession, the US dollar has risen 20% against the Euro, 30% against the British Pound, and 40% against the Australian dollar. The only major currencies that have not significantly depreciated against the dollar are the Chinese Yuan and the Japanese Yen--but they are insignificant because relative to imports, the United States does not export much to China or Japan. Hence, the currencies of America's largest export markets have depreciated significantly, making American exports 20%, 30%, and 40% more expensive than their foreign counterparts. Whether you buy things from one country or another may change if it suddenly costs 20-40% more to purchase from that country. This in turn leads to lower exports from the United States, dashing our hopes for a significant export-led expansionary path.
2. Financial market: As you may know, in the past year there have been significant meltdowns in the financial market--the sudden collapse of Bear Stearns, Lehman Brothers, Merrill Lynch, Washington Mutual and Wachovia Bank (among others)--and extreme public policy attempts to ease the pain--the United States financial rescue package, Europe's guarantee of inter-bank lending, etc. The goal of the latter is to mitigate the damages from the former--credit crunch. When there is very little loans available because banks are afraid of losing money, investment and growth grinds to a halt, dashing our hopes for a quick recovery.
3. Economic growth abroad: Last year it seemed that the rest of the world (including Europe) was on solid ground economically with Europe's primary fear being inflation, China's economy zipping ahead at 12% a year, and Japan finally crawling out of its Lost Decade--the problems in the world seemed confined to America's real estate and construction industries. But we were quickly proven wrong. The financial debacles that afflicted American industries had their counterparts abroad; Europe's economy is shrinking, its financial system is under stress, Ireland went bankrupt, and Switzerland could corrupt its currency any minute by printing money to bail out the Bank of Switzerland. The US can't count on sustained demand from abroad to bolster is economy and keep it from slipping into a recession. The whole world is experiencing a US-led slowdown. True globalization has finally taken shape.
4. Population changes: But some of the growth figures are misleading. Europe's population isn't growing. Italy's struggling with a population decrease. France is finding the same. But 2% growth spread over a smaller labor force growth rate is better than a 2% growth spread over a quickly-growing labor force--it's the production per capita that is the determinant of standards of living. Yet not even the anemic global growth can hide the imminent slowdown in the next half decade--the full retirement of the boomers and their subsequent liquidation of their holdings in the financial markets.

So what do I gather from these changes? That the slowed growth in the rest of the world will not be enough to pull America back from the brink of recession. Considering the significantly higher unemployment rate here, it is likely that GDP growth has paused, or maybe even receded--with 1-2% fewer people working, we're likely to produce at least 1-2% less in aggregate.

Let's hope the recession will be brief--that our governments to whom we entrust our financial and physical security will do their best to stem the loss in consumer and investor confidence, to turn back a tide similar to the one that hit us nearly eight decades ago.

What do you think about the prospects of recession and the duration/impact of it? Berkshire's Buffet believes that we have hit a market bottom, and the fact that he is the world's richest investor gives his voice heavy weight--but is he right?