The U.S. economy is driving along without much insurance for when it crashes.
Almost six years since the bottom of the last recession, the world’s largest economy lacks the monetary and fiscal power to reverse the next contraction as threats to sustained growth build. Having run 70 months so far, the current expansion is about the same length as the average of five cycles since the end of the 1970s.
“We’re probably closer to the next recession than we are to the last one,” Stephen King, chief global economist at HSBC Holdings Plc in London, said in a telephone interview. “If I was a policy maker having sleepless nights it would be partly related to what I would do if there was a recession.”
The fear is there’s not much they can do. In the slumps since the 1970s the Fed cut its benchmark interest rate by an average 6.2 percentage points and a minimum of 5 points, yet at near zero now such a response is impossible, King wrote in a report this week. More quantitative easing could end up only powering asset prices rather than demand, he said.
Although the federal budget deficit has narrowed to about 3 percent of gross domestic product, that’s still more than before most of the past downturns and the government’s debt is larger than before the 2008 financial crisis.
“By now in previous economic cycles, policy will have normalized,” said King. “If there was a recession now it would be much more difficult to fight out of it.”
It’s little surprise the policy armory hasn’t been replenished. The current recovery is weaker than the last five upswings with average growth since the recession’s trough only just topping 2 percent. Inflation is lackluster with King noting the Fed has never raised rates when it has been so weak.
So while the Fed took 31 months in the last period of growth to boost rates, this time it’s gone 70 months and counting without doing so.
Intensifying his concern is that King sees a series of potential contraction triggers. Stocks could slide if higher U.S. wages alongside weak productivity erode profits. The non-bank financial system of pension funds and insurance companies may struggle to meet future liabilities, while a slump in China could drag the U.S. down. The Fed could also err by tightening policy prematurely as the European Central Bank did in 2011.
Doubting the ability of policy makers to avoid a recession or to refashion stimulus, King is left with an unorthodox solution for how they can build back the scope to fight economic shrinkage.
He would spur people to save less by having them retire later with the resulting pickup in demand creating the higher tax revenues and interest rates needed to repel the next downturn. The problem is older people are more likely to vote than the young, weakening the chances of such reform.
“As a result, the recession-fighting ammunition will remain in short supply and the risks of a major economic contraction will be that much greater,” said King.