roach on the us economy

  1. 374 Posts.
    Stephen Roach (New York), Chief economist for Morgan Stanley

    The just-released US GDP report for the fourth quarter of 2002 is an
    important warning sign. It paints a picture of a US economy that has slowed
    to its "stall speed" before it was hit with the full force of any impacts
    associated with looming war in Iraq. To the extent that a further shock is
    in the offing, I fear it will be exceedingly difficult for the United States
    to avoid a recessionary relapse. The risk is it may already be too late.
    My argument rests on a time-honored "recession model" that is really
    applicable to any economy. It has two components -- the so-called
    pre-recession stall and an exogenous shock. There is no precise metric as to
    what constitutes an economy's stall speed. I define it essentially as a
    sluggish growth rate that leaves the real economy lacking in the cyclical
    immunities that are required to cushion it against unexpected blows. In the
    case of the US economy, I would place the current GDP stall speed in the 1%
    to 2% range. If the rate of growth slows into this range, then it doesn't
    take much of a shock to produce a recession.

    That's exactly the way it worked in 1990. By the second quarter of that
    year, annualized real GDP growth had slowed to 0.9% on a sequential
    quarterly basis (or 1.6% on a year-over-year basis). This downshift was in
    response to a late-cycle Fed tightening aimed at staving off a classic
    cyclical build-up of inflation. As the economy slowed in response, the Fed
    was given great credit for achieving the heretofore impossible -- the
    ever-elusive soft landing. For a few fleeting moments it actually appeared
    as if that scenario was actually coming to pass. The outcome of sub-par
    growth was just what was needed to lower the inflation rate, which had risen
    at the time to 5.5% ( as measured on a CPI-basis). Alas, the landing quickly
    went from soft to hard.

    Saddam Hussein marched into Kuwait in early August
    1990, and oil prices shot up. They briefly pierced the $37.50 threshold for
    four weeks in late September and early October before receding sharply
    thereafter. But by then the damage had been done -- a stalling economy had
    been hit by a shock. And the recession of 1990-91 was under way.
    Such an outcome seems all the more relevant today. Real GDP growth was just
    reported to have slowed to a 0.7% annualized clip in 4Q02, little different
    from the stall-speed-like outcome recorded in the pre-Gulf War quarter of

    While the year-over-year growth rate of 2.7% in 4Q02 is a full
    percentage point faster than that prevailing in the just prior to the
    recession of 1990-91, there can be no mistaking the decided loss of momentum
    in the US economy. In the final three quarters of last year, annualized real
    GDP growth averaged just 2% -- anemic by the standards of past cyclical
    recoveries. Moreover, that's actually a good deal further below the current
    potential growth rate (3% to 3.5%) than was the case in the summer of 1990,
    when the 1.6% growth outcome was only slightly below potential growth norms
    that were then closer to 2%.

    Moreover, the detail by sector reveals a US economy that is now in danger of
    losing its most important source of economic growth -- the American

    Personal consumption expenditures increased by just 1.0% in 4Q02;
    that's the slowest quarterly increase in nearly ten years and a further
    deceleration from the more moderate 3% pace that had already been evident in
    the first three quarters of the year. Nor is the economy really firing on
    any other cylinders. A puny increase in business capital spending (+1.5%)
    was offset by a fallback in exports (-1.7%), as growth around the world
    sagged. The only real support to private final demand came from an
    end-of-cycle increase in residential construction expenditures (+6.8%). In
    other words, it is hardly stretching the imagination to describe the current
    state of the US economy as being in the stall-speed vicinity.

    Based on the simple recession model outline above, that means a significant
    shock could well threaten the sustainability of this nascent economic
    recovery. Such a conclusion should hardly be taken lightly in the context of
    the mini-oil shock that is now in the process of unfolding. Over the past
    year, crude oil prices as measured on a West Texas Intermediate basis are up
    over 65% (from $20/bbl at the start of 2002 to $33.85 today). Ironically,
    this increase is comparable to that which also occurred in the 1990 run-up
    to the Gulf War. Oil prices started that year at about $22.50/bbl before
    surging briefly over $37.50 in the immediate aftermath of the invasion of
    Kuwait. In other words, on a percentage change basis, today's oil price
    run-up is already comparable to that which occurred in 1990. Needless to
    say, to the extent that oil prices now move any higher as the Iraq problem
    escalates, the case for a shock becomes all the more compelling. For a US
    economy now hovering at its stall speed, that's hardly a comforting

    History often has strange ways of repeating itself -- as does the so-called
    political-economic cycle. It's hard not to be struck by the irony of these
    two situations -- the Gulf War of 12 years ago and the looming battle in
    Iraq in early 2003. In both cases, a George Bush was sitting in America's
    White House, each riding the crest of a great wave of popularity. But in
    both cases, a stalling US economy was hit by a brief oil shock. In 1991,
    that combination was sufficient to produce a mild recession that ended up
    costing "Father Bush" the presidency.

    While the jury is still out on the
    economic ramifications of the current oil shock, there can be no mistaking
    the risks. Indeed, in many respects, today's post-bubble US economy is in
    far worse shape than the economy was back in 1990. That's certainly the
    verdict on the basis of America's serious imbalances -- a record
    current-account deficit, a record-low net national saving rate, and record
    levels of private sector indebtedness. To the extent that these lingering
    structural excesses continue to spawn powerful economic headwinds, the
    combination of the stall and the shock looks all the more troubling in early
    2003. In my view, the risks of a recessionary relapse are high and rising.
    America is back on the edge.

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