WASHINGTON – The U.S. economy appears destined for several years of weak growth and high unemployment that leave it vulnerable to a recession relapse after the massive dose of government stimulus wears off.
While tepid growth looks likely to resume late this year and build modestly into 2010, the credit bust has left households and businesses unable or unwilling to borrow and spend as freely as they did before the crisis.
The U.S. government has stepped in as lender and spender of last resort, but its deep pockets are not bottomless. Waning political and investor appetite for taking on more debt could stand in the way of any additional big spending plans.
“When you remove the government stimulus, what the private sector can generate in terms of growth feels like a recession,” said Jeffrey Rosenberg, head of global credit strategy at Banc of America Securities Merrill Lynch in New York.
Rosenberg thinks the U.S. economy may trudge along at a sluggish growth rate somewhere in the range of 0.5 per cent to 1.5 per cent while banks recover from the credit crisis, which could take another three years.
“If that’s what you’re able to generate, that economy is not generating the job growth required to bring the unemployment rate down,” Rosenberg said.
This is a much darker outlook than the one put forward by President Barack Obama’s administration in its latest budget projections, which show economic growth bouncing back to 3.2 per cent next year and hitting 4.6 per cent by 2012.
It also calls into question the staying power of a recent stock market rally. The Standard & Poor’s 500 is up more than 30 per cent from an early March low.
The gloomier scenario assumes that banks take years to recover from losses that some economists think could reach $4 trillion; consumers curb borrowing and spending as they repair the $11.2 trillion hole blown through their savings last year; and the explosion in government debt drives up interest rates.
If the forecast proves accurate, it would leave the economy susceptible to a shock, such as a big jump in oil prices, and could force the United States to issue even more debt than investors expect. That would likely increase borrowing costs, both for the government and the private sector.
NEVER SAY NEVER
Typically, deep recessions are followed by powerful recoveries because when demand finally returns, companies quickly ramp up production. That helps explain why Wall Street has been feeling optimistic about recovery prospects.
However, recessions caused by financial crises have a history of being long, deep and difficult to fully escape.
Treasury Secretary Timothy Geithner said Thursday that the current crisis was “caused in large part by too much borrowing and too much lending. And the adjustment process of that will be difficult.”
How difficult that adjustment will be depends to a large degree on how dramatically consumers alter their behaviour.
The saying, “Never bet against the U.S. consumer” has been a profitable one for many years. But if this crisis has permanently altered consumer attitudes toward debt, it would put a considerable drag on growth because consumer spending accounts for more than two-thirds of U.S. economic activity.
The other anchor is interest rates. Christian Broda, an economist with Barclays Capital, said higher borrowing costs “are an inescapable feature of the post-recovery world” as public deficits and spending grow.
Already, huge government debt issuance is raising questions about long-term U.S. fiscal stability. Concerns grew last week that the country could be stripped of its top-tier AAA credit rating after Standard & Poor’s said it was considering downgrading Britain’s sovereign rating.
This week marks a big test of investor appetite for U.S. debt. The government plans to issue a massive $101 billion in notes and bonds, matching the weekly record set in April.
Broda thinks the yield on 10-year U.S. government paper may reach 6 per cent by 2011, compared with 3.4 per cent now. Because so many other loans are based on that rate, that could make it costlier to buy a house or expand a business.
NO WAY OUT
It all adds up to a sluggish economy with less cushion to cope with a shock. What form that shock might take remains to be seen, but a jump in oil prices is one likely suspect. Oil has nearly doubled since the start of the year, topping $60 per barrel Tuesday, and futures prices suggest it will edge higher at least through the peak summer driving season.
“You start firing up demand and guess which price goes up first? Oil,” said James Galbraith, an economist who teaches at the University of Texas’ LBJ School of Public Affairs.
“If I were in a position to be talking strategy to the (Obama) administration, I would be saying you’ve got to take the energy business seriously. You’re going to end up in a stagflation trap.”
If the economy climbs out of one recession and into another, it wouldn’t be the first time. It happened most recently in the early 1980s, when the United States endured two recessions in less than three years.
Regardless of what triggers a relapse, the Obama administration won’t stand idly by, Banc of America’s Rosenberg said. There will be pressure for even more stimulus spending, particularly if the economy is faltering when midterm congressional elections approach in 2010.
“The problem is whether or not (stimulus) can work without itself creating other problems,” Rosenberg said. “The most likely ‘other problem’ is a rise in interest rates.
“What one hand giveth, the other hand taketh away.”