The Shape of America’s Recession
NEW YORK – Now that it is clear that the United States is in recession, the debate has moved on to whether it will be short and shallow or long and deep – a question that is as important for the rest of the world as it is for the US.
The answer depends on the shape of the US recession: if it is short and shallow, sufficient growth elsewhere will ensure only a slight global slowdown. But if the US recession is long and severe, the result could be outright recession in some countries (the United Kingdom, Spain, Ireland, Italy, and Japan), and even financial crises in vulnerable emerging-market economies.
In principle, the US recession could end up being shaped like a V, U, W, or L. Which of these four scenarios is most likely?
The current consensus is that the recession will be V-shaped – short and shallow – and thus similar to the US recessions in 1990-91 and 2001, which lasted eight months each. Most analysts forecast that GDP will contract in the first half of 2008 and recover in the second half of the year.
I expect a longer and deeper U-shaped recession, lasting at least 12 months and possibly as long as 18 months – one of the most severe US recessions in decades – because today’s macroeconomic and financial conditions are far worse.
First, the US is experiencing its worst housing recession since the Great Depression, and the slump is not over. Construction of new homes has fallen about 50%, while new home sales are down more than 60%, creating a supply glut that is driving prices down sharply – 10% so far and probably another 10% this year and in 2009.
Already, $2.2 trillion of wealth has been wiped out, and about eight million households have negative equity: their homes’ are worth less than their mortgages. By 2010, the fall in home prices will be close to 30% with $6.6 trillion of home equity destroyed and 21 million households – 40% of the 51 million with a mortgage – facing negative equity. If owners walk away from their homes, credit losses could be $1 trillion or more, wiping out most of the US financial system’s capital and leading to a systemic banking crisis.
Second, in 2001, weak capital spending in the corporate sector (accounting for 10% of GDP) underpinned the contraction. Today, it is private consumption in the household sector (70% of GDP) that is in trouble. American consumers are shopped-out, saving-less, debt-burdened (136% of income, on average), and buffeted by many negative shocks.
Third, the US is experiencing its most severe financial crisis since the Great Depression. Losses are spreading from sub-prime to near-prime and prime mortgages, commercial mortgages, and unsecured consumer credit (credit cards, auto loans, student loans). Total financial losses – including possibly $1 trillion in mortgages and related securitized products – could be as high as $1.7 trillion.
Given these staggering sums, the US could face a double-dip, W-shaped recession. The main question is whether the tax rebate that US households will receive in mid-2008 will be consumed – thus leading to positive third-quarter growth – or saved. Given how financially stretched US households are, a good part of this tax rebate may be used to pay down high credit card balances (or other unsecured consumer credit) or to postpone mortgage delinquency.
Fortunately, an L-shaped period of protracted economic stagnation – Japan’s experience in the 1990’s – is unlikely. Japan waited almost two years after its asset bubble collapsed to ease monetary policy and provide a fiscal stimulus, whereas in the US both steps came early. Moreover, whereas Japan postponed corporate and bank restructuring for years, in the US private and especially public efforts to restructure assets and firms will start faster and be more aggressive.
Still, given a severe financial crisis, declining home prices, and a credit crunch, the US is facing its longest and deepest recession in decades, dashing any hope of a soft landing for the rest of the world. While a global recession will be averted, a severe growth slowdown will not. Many European economies are already slowing, with some entering recession. China and Asia are particularly vulnerable, given their trade links to the US. And emerging markets will suffer once the US contraction and global slowdown undermines commodity prices.
Nouriel Roubini is Professor of Economics at New York University and Chairman of RGE Monitor (www.rgemonitor.com).
Copyright: Project Syndicate, 2008. Visit Project Syndicate at http://www.project-syndicate.org