Friday, August 11, 2006

Recession: probability now 70%

The odds that the US will slide into recession have risen since last month from 50 per cent to 70 per cent by my estimates.

The implications will be felt globally. The rest of the world will not decouple from the US economic train, as some analysts predict. When the US sneezes, the rest of the world still gets the cold.

The US recession will be triggered by three unstoppable forces: the housing slowdown; high oil prices; and higher interest rates. The US consumer, already burdened with high debt and falling real wages, will be hard hit by these shocks.

The effects of the housing slump will be more severe than those following the technology bubble implosion in 2001. The negative wealth effect on consumption of falling housing prices - and the related sharp fall in home equity withdrawal - are also larger than the wealth effects of the collapse of tech stocks in 2000. Property, unlike the tech stocks, is a significant part of household wealth. Finally, about 30 per cent of US employment in the latest recovery has been related to housing.

Higher investment in equipment and software, expected to offset lower spending on housing and consumption, is instead falling.

There are now serious limits to monetary easing; even though global inflation is up, fiscal policy cannot be eased as almost all of the G7 countries face serious fiscal imbalances.



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