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