After Record-Long Expansion, Here’s What Could Knock the Economy Off Course (#GotBitcoin?)
Experts see the U.S. continuing to grow, but looming risks include trade wars, interest-rate mistakes and the ballooning budget deficit. After Record-Long Expansion, Here’s What Could Knock the Economy Off Course (#GotBitcoin?)
Economies aren’t like cars. They don’t just wear down and peter out after running for several years. Something needs to happen to knock them off course.
That’s potentially good news as the U.S. expansion reaches its 10-year mark this month. By July, it will become the nation’s longest on record—eclipsing the decadelong expansion of the 1990s—and there’s no economic rule that says it must end.
While many economists say this one is in position to keep going, risks are looming, most notably threats of tariff-driven trade wars with China, Mexico and others that damage business, household and investor confidence. A central bank mistake with interest rates is also a threat, and—because of the country’s ballooning budget deficit—fiscal policy is in a weaker position to help through spending or big tax cuts if the economy becomes stressed. Moreover, structural issues that develop as expansions age make them somewhat vulnerable to mishap.
A great deal rides on the outlook, including the fortunes of millions of American workers who benefited from a long period of very low unemployment and of investors who have seen their wealth climb. Donald Trump, meanwhile, is counting on a strong economy to secure his re-election in 2020.
More than 20 million jobs have been created so far in the expansion that started in mid-2009, and the net worth of American households—the value of assets such as stocks and housing minus debts such as mortgages and credit cards—has increased by $47 trillion.
Though the U.S. expansion has been a long one, it has lacked vigor. The growth rate has been the most anemic on record, and the jobless rate took years to recede, with lower-skill workers seeing their main gains in just the past couple of years.
Wage growth also has been slow, though when adjusted for very low inflation real wages have grown more robustly than in other expansions. For many households, meanwhile, growing student debt loads have been a burden, and many of the gains from a strong market and recovering home prices went to the highest-income households.
Since World War II, the average U.S. expansion has lasted just 58 months, less than half as long as the current one, but periods of extended growth have been common in many other nations.
Australia is enjoying its 28th straight year of growth. Canada, the U.K., Spain and Sweden had expansions that reached 15 years and beyond between the early 1990s and 2008. Without the Sept. 11, 2001, terrorist attacks the U.S. might have, too.
France, Germany, the Netherlands, Norway, South Korea, Ireland, China and others have likewise experienced sustained periods of economic growth that lasted 15 years or more at different points since World War II, according to the Economic Cycle Research Institute and an analysis of global growth data.
Good luck, good policy and the long roads economies sometimes travel to regain ground after major downturns combined to produce these events. As long as the labor force is growing and workers are becoming more productive, economies, in theory, should keep growing.
Three Factors Tend To Trip Them Up: Shocks, Excesses And Central Banks
In 1990, an oil price shock related to Iraq’s invasion of Kuwait helped to sideswipe U.S. economic growth. It drove up gasoline prices and squeezed consumers and business profits. In 2001, the reversal of technology investment excesses derailed a strong U.S. economy. A stock price collapse destroyed investor wealth and crimped household spending plans, while businesses reined in investment. The Sept. 11 terrorist attacks were an added shock to an economy already on edge. In 2007, a housing bust and budding banking system crisis combined excess and shock to send the U.S. deep into recession.
Each of those cases was preceded by Fed interest-rate increases, which were meant to stop excesses from building. Higher rates hurt interest-sensitive sectors like housing and car buying and make it more costly for businesses to invest. In the most glaring example of the central bank’s key role in the U.S. business cycle, the Fed in the early 1980s pushed short-term interest rates sharply higher to tame double-digit inflation, driving the U.S. into a double-dip recession. In 1997, MIT economist Rudi Dornbusch wrote, “None of the U.S. expansions of the past 40 years died in bed of old age; every one was murdered by the Federal Reserve.”
The central bank earlier this year shelved further interest-rate increases, and many economists believe its next move will be a rate cut.
Glenn Rudebusch, an economist at the Federal Reserve Bank of San Francisco, studied U.S. recessions as an insurance actuary might study the incidence of death in the population. An 80-year-old person is more likely to die in his 81st year than a 50-year-old person is to die at 51. But expansions don’t behave that way, he found. An expansion in its eighth year was no more likely to end than one in its fifth.
“There was no particular time or age at which an expansion would end,” he says of the research.
Mr. Rudebusch notes that the hangover from the 2007-09 recession may have restrained the kinds of excesses in the current expansion that led to downturns in the past.
In the past five years, for example, U.S. financial sector debt has increased 9%, compared with a 64% increase in the five years before the last recession. Household debt is up 14%, compared with a 65% increase in the five years before the recession. While student debt and credit card debt has grown, the growth in mortgage debt, which helped spark the last downturn, has been modest in this expansion. Strong debt growth can lead to excessive spending and investment and problems for banks that are owed money that isn’t returned.
This time around, says Mr. Rudebusch, “there was probably some investor caution and more regulatory scrutiny that helped ensure that we weren’t going to sow some of the seeds of recession.”
Former central bank officials in Australia and Canada say financial regulatory scrutiny was an important factor in the long upturns their economies experienced, too. “We had stronger supervision of our banking system,” says Tiff Macklem, dean of the University of Toronto’s Rotman School of Management and former Bank of Canada official. “That was one reason why we got through the 2008 recession without any bank failures.”
Central banks can respond to big downturns by holding interest rates lower for longer to spur growth to make up for lost ground, as the U.S. Federal Reserve has over the past decade.
Big recessions also sometimes prompt policy changes that help sustain growth. In Canada, large government budget deficits and high inflation led to severe belt tightening, pushing its unemployment rate to more than 11% in 1992. In reaction, Canada created an inflation target that stabilized the economy and advanced fiscal-policy changes that led to budget surpluses by 1997. Those surpluses became a tool to fight recession later.
“We certainly never thought we had licked the business cycle, but we did believe we had put macroeconomic policy on a better track,” says Mr. Macklem. “By the time you got to the end of the 1990s, we had 10 years of low, stable inflation and we dealt with the fiscal challenge and now had a relatively low debt to [economic output] ratio.”
The U.K. also started a 1992-2008 run of growth with a crisis: The British pound tumbled when the U.K. withdrew from the European Exchange Rate Mechanism, and unemployment climbed to more than 10%. A severely weakened currency helped drive an export-led recovery and a newly independent central bank helped stabilize the economy in the 1990s.
Canada and the U.K. escaped the 2001 technology bust. Australia did, too.
“The 28-year upswing contrasts sharply with five recessions in the 30 years which preceded its commencement,” says John Edwards, a senior fellow at the Lowy Institute in Sydney and former Reserve Bank of Australia official.
Like Canada, Australia’s pre-expansion period in the 1980s and early 1990s was marked by economic malaise, including high inflation and budget deficits that officials set out to reverse with a central bank inflation target and fiscal belt tightening. It also helped that the country became a major exporter of commodities to fast-growing China.
“The whole experience is a reminder that expansions are not less likely to continue just because they have already been going on for a while,” Mr. Edwards says. “Australians these days don’t talk as much about the ‘economic cycle’ as we once did.”
In the U.S.’s 10-year expansion of the 1990s, a resurgence of worker productivity was tied to the increased use of technology. A steady slowdown in inflation also allowed the Fed to keep interest rates low. Then tech stock gains became a bubble that unwound in 2000 and 2001.
The current U.S. expansion has some trends going in its favor. Unlike the 1970s and early 1980s, inflation is low, taking pressure off the Fed to raise interest rates. The U.S. has become a large exporter of oil, making it far less susceptible to another oil price shock. Productivity growth is accelerating after a long period of dormancy, and a strong economy is drawing workers into the labor force.
Robert Gordon is a professor at Northwestern University and member of the National Bureau of Economic Research committee that dates U.S. recessions. He says he thought last fall that the U.S. was heading toward recession because unemployment had fallen so low and seemed to be setting the stage for inflation and sustained interest-rate increases. Instead, inflation is undershooting the Fed’s 2% objective.
“The Fed is usually tightening throughout the process of the last year or two of the expansion,” Mr. Gordon says. With inflation low and the Fed on hold, he says, “there is a very good chance we can get through 2020 and 2021 with only a modest slowdown.” Trade conflicts might dent growth, he said, but probably won’t derail it.
Though the age of an expansion itself doesn’t cause recession, older expansions can become vulnerable. One reason is that excesses tend to build late in the cycle—when unemployment is low, confidence is high and risk aversion among businesses, investors and individuals is forgotten. Though household and financial debt are now low, corporate debt has grown faster in this expansion than in the last one.
This is also the stage in an expansion when the central bank has shifted its stance, from nurturing growth with low interest rates to preventing excesses with higher rates, raising the chances of a policy mistake. In recent months, short-term U.S. rates have edged higher than long-term rates on occasion, a market signal that some investors believe the Fed may have already pushed short-term rates up too much, even though they are historically low at less than 2.5%.
“Expansions don’t die of old age, but when you are cruising along at full employment, you have more vulnerability,” says James Stock, a Harvard University professor who has studied what makes expansions end.
Some countries escaped recession in the 1990s and 2000s, only to build up deep excesses that made their later recessions even more severe, notes Mark Zandi, chief economist at Moody’s Analytics. Spain, for example, avoided recession from 1993 to 2008 in an expansion that became driven by excessive property lending and investment. When recession hit, the unemployment rate soared from less than 8% to more than 26% during a period of six years.
“All kinds of excesses were building” during its expansion, Mr. Zandi says. “It was a doozy of a recession.”
Mr. Zandi ran several scenarios through his computer model of the U.S. economy to assess what could cause a recession now. The prime risk, he says, is a trade war driven by the U.S.
If Mr. Trump follows through on all of his threatened tariff increases, including 25% tariffs on all Chinese goods, 25% tariffs on imports from Mexico and tariffs on U.S. car imports, it would act like a massive tax increase on U.S. households and businesses, straining confidence and markets and knocking the U.S. into recession in 2020, he said.
Mr. Zandi said his model showed full scale trade war would lead U.S. employment to drop by 3.1 million between the third quarter of this year and mid-2021, while the jobless rate would rise from less than 4% to 6.6% by mid-2021. Stock values, he added, would drop 37%.
Mr. Zandi assumes China would retaliate, in part by allowing its currency, the yuan, to depreciate in value, hurting U.S. manufacturing, and curtailing purchases of U.S. Treasury bonds, pushing up interest rates and hurting homeowners and stocks.
Fiscal Policy Is Another Point Of Uncertainty For The U.S.
When Australia’s economy was hit during the 2007 to 2009 financial crisis, policy makers responded by cutting taxes and increasing spending to cushion the blow and keep the expansion going. It had wide latitude thanks to budget surpluses built in previous years.
The U.S. is now going in a starkly different direction, heading toward a trillion dollar budget deficit even after a decade of economic expansion. Recent tax cuts and federal spending have helped to boost growth in the short run and possibly boosted the long-run outlook by increasing business investment.
But if a threat hits the economy, policy makers may have a difficult time finding further tax or spending capacity to limit the impact. As Canada experienced in the early 1990s, fiscal belt tightening in a downturn can make a recession even worse.
The Fed is also constrained. With interest rates already very low, it has little room to cut them to spur borrowing, spending and investment in a downturn.
A recent survey shows most economists don’t expect a recession until 2021 or later.
Mr. Zandi says the risks are higher than others might believe. “The Fed has never been able to soft land the plane,” he warns. After Record-Long Expansion, Here’s, After Record-Long Expansion, Here’s,After Record-Long Expansion, Here’s,After Record-Long Expansion, Here’s,After Record-Long Expansion, Here’s,After Record-Long Expansion, Here’s,After Record-Long Expansion, Here’s
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