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While the risk of a disorderly crisis in the eurozone is well recognized,a more sanguine view of the United Stateshas prevailed. For the last three years, the consensus has been that the USeconomy was on the verge of a robust andself-sustaining recovery that would restore above-potential growth. That turnedout to be wrong, as a painful process ofbalance-sheet deleveraging – reflecting excessive private-sector debt, and thenits carryover to the public sector – impliesthat the recovery will remain, at best, below-trend for many years to come.
Even this year, the consensus got it wrong, expecting a recovery toabove-trend annual GDP growth – faster than 3%. But the first-half growthrate looks set to come in closer to 1.5% at best, even below 2011’s dismal1.7%. And now, after getting the first half of 2012 wrong, many are repeatingthe fairy tale that a combination of loweroil prices, rising auto sales, recovering house prices, and a resurgence of USmanufacturing will boost growth in the second half of the year and fuelabove-potential growth by 2013.
The reality is the opposite: for several reasons, growth will slow furtherin the second half of 2012 and be even lower in 2013 – close to stall speed. First, growth in the second quarterhas decelerated from a mediocre 1.8% inJanuary-March, as job creation – averaging 70,000 a month – fell sharply.
Second, expectations of the “fiscal cliff”– automatic tax increases and spending cuts set for the end of this year – willkeep spending and growth lower through the second half of 2012. So willuncertainty about who will be President in 2013; about tax rates and spendinglevels; about the threat of another government shutdown over the debt ceiling;and about the risk of another sovereign rating downgrade should politicalgridlock continue to block a plan for medium-term fiscal consolidation. In suchconditions, most firms and consumers will be cautious about spending – anoption value of waiting – thus further weakening the economy.
Third, the fiscal cliff would amount to a 4.5%-of-GDP drag on growth in2013 if all tax cuts and transfer payments were allowed to expire and draconian spending cuts were triggered. Of course,the drag will be much smaller, as tax increases and spending cuts will be muchmilder. But, even if the fiscal cliff turns out to be a mild growth bump – amere 0.5% of GDP – and annual growth at the end of the year is just 1.5%, as seemslikely, the fiscal drag will suffice to slowthe economy to stall speed: a growth rate ofbarely 1%.
Fourth, private consumption growth in the last few quarters does notreflect growth in real wages (which are actually falling). Rather, growth indisposable income (and thus in consumption) has been sustained since last yearby another $1.4 trillion in tax cuts and extended transfer payments, implyinganother $1.4 trillion of public debt. Unlike the eurozone and the UnitedKingdom, where a double-dip recession is already under way, owing to front-loaded fiscal austerity, the US hasprevented some household deleveraging through even more public-sectorreleveraging – that is, by stealing some growth from the future.
In 2013, as transfer payments are phased out,however gradually, and as some tax cuts are allowed to expire, disposableincome growth and consumption growth will slow. The US will then face not only thedirect effects of a fiscal drag, but also its indirect effect on privatespending.
Fifth, four external forces will further impede US growth: a worseningeurozone crisis; an increasingly hard landing for China; a generalized slowdownof emerging-market economies, owing to cyclical factors (weak advanced-countrygrowth) and structural causes (a state-capitalist model that reduces potentialgrowth); and the risk of higher oil prices in 2013 as negotiations andsanctions fail to convince Iran to abandon its nuclear program.
Policy responses will have very limited effect in stemmingthe USeconomy’s deceleration toward stall speed: even with only a mild fiscal drag ongrowth, the US dollar is likely to strengthen as the eurozone crisis weakensthe euro and as global risk aversionreturns. The US Federal Reserve will carry out more quantitative easing this year,but it will be ineffective: long-term interest rates are already very low, andlowering them further would not boost spending. Indeed, the credit channel isfrozen and velocity has collapsed, withbanks hoarding increases in base money inthe form of excess reserves. Moreover, thedollar is unlikely to weaken as other countries also carry out quantitativeeasing.
Similarly, the gravity of weaker growth will most likely overcome the levitational effect on equityprices from more quantitative easing, particularly given that equityvaluations today are not as depressed as they were in 2009 or 2010. Indeed,growth in earnings and profits is now running outof steam, as the effect of weak demand ontop-line revenues takes a toll onbottom-line margins and profitability.
A significant equity-price correction could, in fact, be the force that in2013 tips the USeconomy into outright contraction. And ifthe US (still the world’slargest economy) starts to sneeze again, therest of the world – its immunity alreadyweakened by Europe’s malaiseand emerging countries’ slowdown – will catch pneumonia.
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