Regardless, there is mounting evidence of a serious economic slowdown and recent economic data makes this clear. Inflation is higher and unemployment has reached 5 percent in December 2007. While the slowing economy was at first blamed only on the housing sector and credit market, now the Philadelphia Federal Reserve has released data showing a much lower-than-expected manufacturing index for February.
Most important is the index the Conference Board uses to gauge future business activity. This index of leading economic indicators has now dropped 2.0 percent over the last six months, the biggest drop since 2001.
This index is used to forecast where the U.S. economy is heading in the next three to six months. Persistent and significant designs signal a recession is near: in the six months before the last recession in 2001 the index fell by 2.2 percent, and the average six-month decline before most recessions is 2.5 percent.
So we are very close to that average. Some of the numbers behind the decline are easy to spot: retail spending was down over the Christmas shopping season, building activity is down 16.9 percent, and the Dow Jones index was down 13 percent in the three months from December 2007 to February 2008 (a bear market is a decline of 10 percent).
On top of this you have the ongoing housing crisis. Housing starts are down 40 percent compared to the peak in 2006, and average home prices dropped 7 percent in 2007. It’s not hard to picture a drop of 15-20 percent in house prices once the full extent of the subprime crisis is felt. Preliminary figures point to losses of USD 70 billion for U.S. banks.
Nonetheless, 2007 saw four consecutive quarters of growth. So the official definition of a recession was not met. The panic started when fourth quarter fell to 0.6 percent, half the expected figure and well below the 4.9 percent recorded in the third quarter. Overall growth for 2007 will be about 2.2 percent, the lowest level since 2002 when the U.S. was recovering from another slowdown.
And what about 2008? Despite the dire news reports, economists still expect growth of about 1.9 percent this year. But this is hardly an exciting figure and the key adjustment policies taken by the U.S. authorities indicate major economic weakness and serious policy concern.
Policies to deal with slowdown
The Federal Reserve cut 50 basis points off the (short-term) fund rate on 30 January 2008, after a sudden cut of 75 basis points the previous week. This signaled an aggressive preemptive strike by the Fed against what they called ‘remaining downward risks.’ Notably absent was concern for inflation which previously had been the Fed’s chief concern prior to the current crisis.
A fiscal stimulus package of some USD 150 billion was adopted by the US Government. This package includes individual tax rebates (USD 600 per person, USD 1,200 per tax-paying couple, and USD 300 per child) and other tax cut measures. However as some aspects of the package will be slow to materialise the impact will not be quick enough to help prevent a recession if it does happen in 2008.
Impact on world markets
The three basic interest rates in the world economy are now the U.S. at 3 percent, the ECB at 4 percent, and Japan at 0.5 percent. The decline in U.S. interest rates will lead to a downward trend in world market rates.
Since the ECB and Japan are not going to change their interest rate policy in a significant way, this points to further weakening of the USD compared to the Euro, the British pound and the Yen. Other exchange rates in the dollar area, namely Australian and New Zealand dollars, are also expected to appreciate against USD.
For the Asian region, since most countries (notably China and ASEAN) link their currencies to the USD, no significant changes in exchange rates are expected to affect their trade competitiveness.
Commodity prices will react to the deteriorating USD, and gold has already hit a new high of over USD 970/ounce in world markets last week (Feb.29), with oil still fluctuating around USD 100/barrel despite news of increased inventories and a supply surge, as well as prospects of weak demand loomed by the US slowdown.
Record prices are also being recorded by other major commodities like platinum, copper, steel and most grains, which will worsen inflation rates in most countries.
Thus, the world economy might face stagflation in which declining interest rates combine with higher inflation to produce negative real interest rates in several countries. This might give rise to a new bout of jumping real estate prices in some countries, e.g. in Hong Kong and Vietnam in Asia. Nevertheless, the long term impact of a recession will be to moderate real estate prices in the medium term.
Pham Do Chi