Last week’s four-part series laying out the reasons for my prediction of a U.S. recession in 2012 elicited a variety of questions and comments from readers that merit a response.
-- Global context: One reader objected to my focus on the U.S. alone: “There is no longer an American economy -- only a world economy. The world economy is very unstable and will continue to be so into the foreseeable future. The U.S. has almost no available policy defenses against this instability, so any progress we make on the jobs and income fronts will sooner or later (mostly sooner) be undone by destabilizing global happenings and global geopolitical competition.”
This is a valid point. The series covered the U.S. economy, but I have written extensively about the other major world markets in my monthly newsletter, “Insight,” and will cover Japan in my next articles for Bloomberg View.
My thinking is as follows: Europe is in a recession that could be as severe as the one in 2008-2009 in which real gross domestic product in the euro area fell 5.4 percent from peak to trough, almost matching the U.S. decline of 5.5 percent. The continuing, unresolved --- and probably unsolvable -- financial crisis has again spilled over into the real economy.
The joining of northern and southern Europe under a common currency, but without a common fiscal policy, has proved untenable. The alternatives to continued bailouts of Greece, Portugal and probably Spain are the dissolution of the euro area, runs on the banks by investors and the risk of a continent-wide depression. The dire outlook was temporarily obscured by the 1 trillion euros ($1.3 trillion) in loans from the European Central Bank to the banks that was used to finance the deficits of weak countries. But those measures simply loaded the red ink onto the balance sheets of the four remaining AAA rated countries -- Germany, the Netherlands, Luxembourg and Finland. In addition, even that massive bailout is losing its punch, as shown by the recent jump in Spain’s sovereign interest rates.
The effects of the euro-zone recession on the U.S. in terms of trade are limited: U.S. exports account for 14 percent of GDP and just 15 percent of those goods go to the euro zone. As a result, the U.S.’s GDP exposure is only 2 percent. More worrisome is that 25 percent of the foreign exposure of U.S. banks is in the euro zone. MF Global Holdings Ltd., which was sunk by leveraged bets on European sovereign debt, may be the canary in the coal mine.
For its part, China reacted to the Great Recession with huge stimulus spending, the equivalent of 12 percent of GDP; by contrast, the U.S. effort in 2009 amounted to 6 percent of GDP. China’s growth revived rapidly, but so did inflation, with double-digit food-price increases in a country where many live at subsistence levels. In addition, Chinese savers, who have few viable investment alternatives, piled into real estate, fueling a property boom that the leadership despises.
In response, the government has slammed on the monetary brakes and made property speculation distinctly unattractive. Furthermore, the Chinese economy remains export-led with consumer spending accounting for a mere 34 percent of GDP, compared with 59 percent in Japan, 58 percent in Germany and 71 percent in the U.S.
The recession in Europe and slow growth elsewhere has cut into Chinese export growth. Real GDP growth in the first quarter was 8.1 percent, down from 8.9 percent in the fourth quarter; it is probably headed for hard-landing levels of 5 percent to 6 percent. When China doubled the allowed for the yuan on April 16, the currency fell. That contradicts the widespread belief that the Chinese currency is still undervalued.
Because China was the foundation of the earlier commodity bubble, the weakness in industrial and agricultural commodity prices in the last year probably indicates not just a global slowdown or recession but also a hard landing in China. Commodity exporters such as Brazil and Australia, and their currencies, are already feeling the effects. Weaker commodity prices, however, will help the profit margins of U.S. producers, wholesalers and retailers who haven’t been able to pass price increases through to consumers.
-- Income inequality: Several readers expressed concern about income polarization in the U.S. and attributed it, correctly, to the maldistribution of education. One reader wrote: “Structural unemployment issues remain an untouched area. There needs to be a consensus to implement skills training and adjustment programs for those who are unemployed because firms are still demanding better-skilled workers.”
True enough. Many U.S. companies are shifting research and development abroad because there aren’t enough engineers and scientists at home to fill the demand. Low grades and high-school achievement scores relative to students abroad are being addressed, partly by standardized testing. But parents as well as teachers are responsible. And persuading college students to spend their afternoons in the physics lab rather than on the playing field or socializing isn’t easy. There are many unemployed residential-construction carpenters, electricians and plumbers, but is it reasonable to expect them to be retrained as software engineers?
-- Housing market: Some readers noted the plight of U.S. housing. One summed it up this way: “In the traditional model, real recovery is hardly possible without housing recovery. If politicians and voters want one, there may be time to find the way to provide housing without loading people with debt. If young people will spend five years amassing a down payment, and another five years paying mortgages and paying down student debt, there will be no money for anything else, and no real recovery in the nearest 10 years.”
I addressed this issue in a Bloomberg View series in February. I explained that there are now about 2 million excess U.S. housing units, over and above normal working inventories for new and existing homes. Some are listed for sale but many aren’t, including foreclosed houses and vacant properties that owners are keeping off the market until prices rise.
At current rates of housing starts and household formation, it will take about four years to work off this excess inventory. That’s plenty of time for those surplus houses to push prices down an additional 20 percent. Also, the $25 billion settlement between mortgage servicers and state attorneys general and the federal government may have cleared the way for mass foreclosures and price-depressing sales.
Foreclosures, stringent lending standards and high unemployment lowered the homeownership rate to 66 percent in the fourth quarter of 2011, from its 69.2 percent peak in the fourth quarter of 2004. It may be on its way to 64 percent, or maybe even lower. I estimate that these conditions will create 3.9 million new renters by 2016. Most will probably be in apartments, but some may rent single-family houses if the problems of maintaining them can be solved to the satisfaction of financial institutions and other large-scale owners.
(A. Gary Shilling is president of A. Gary Shilling & Co. and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.” The opinions expressed are his own. Read Part 1, Part 2, Part 3 and Part 4 of the series.)
This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.
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