Semi-Daily Journal
Brad DeLong's Thoughts of the Moment on Economics, and on Other Topics as Well
DeLong's Home Page
January 31, 2003
Stephen Roach Becomes Even More Gloomy
Stephen Roach becomes even more gloomy about the U.S. economy. And I cannot see how to avoid following his argument to its depressing conclusion.
Morgan Stanley's Stephen Roach has been worried about a double-dip in the United States for a full year now. If I read him correctly, he thinks that the chances of a return to recession are now bigger than 50-50. At some point in the next six months there is going to be a powerful negative external shock coming from somewhere--probably political or military developments in the Middle East. This shock will hit a stalling U.S. economy, and it is more likely than not to push it into recession.
Moreover, in Roach's view it is already too late for changes in monetary or fiscal policy to offset the likely return to recession.
Morgan Stanley: The just-released US GDP report for the fourth quarter of 2002 is an important warning sign. It paints a picture of a US economy that has slowed to its "stall speed" before it was hit with the full force of any impacts associated with looming war in Iraq. To the extent that a further shock is in the offing, I fear it will be exceedingly difficult for the United States to avoid a recessionary relapse. The risk is it may already be too late.
My argument rests on a time-honored "recession model" that is really applicable to any economy. It has two components -- the so-called pre-recession stall and an exogenous shock. There is no precise metric as to what constitutes an economy?s stall speed. I define it essentially as a sluggish growth rate that leaves the real economy lacking in the cyclical immunities that are required to cushion it against unexpected blows. In the case of the US economy, I would place the current GDP stall speed in the 1% to 2% range. If the rate of growth slows into this range, then it doesn?t take much of a shock to produce a recession.
That?s exactly the way it worked in 1990. By the second quarter of that year, annualized real GDP growth had slowed to 0.9% on a sequential quarterly basis (or 1.6% on a year-over-year basis). This downshift was in response to a late-cycle Fed tightening aimed at staving off a classic cyclical build-up of inflation. As the economy slowed in response, the Fed was given great credit for achieving the heretofore impossible -- the ever-elusive soft landing. For a few fleeting moments it actually appeared as if that scenario was actually coming to pass. The outcome of subpar growth was just what was needed to lower the inflation rate, which had risen at the time to 5.5% ( as measured on a CPI-basis). Alas, the landing quickly went from soft to hard. Saddam Hussein marched into Kuwait in early August 1990, and oil prices shot up. They briefly pierced the $37.50 threshold for four weeks in late September and early October before receding sharply thereafter. But by then the damage had been done -- a stalling economy had been hit by a shock. And the recession of 1990-91 was under way.
Posted by DeLong at January 31, 2003 09:45 AM
| Trackback
Well, maybe Bush jr will be the first president who'll have a recession named after him: The W (formerly double-dip) recession - from the shape of the relevant graphs.
I have been selling automobiles for 18 years at the same Ford store. The last three months have been the worst in our history. sales are down 40-45%. This is not a trend that we can sustain. If it were to continue for two or three more months we may well be discussing depression not recession
My neighbours are the proud owners of 3 SUVS, and frankly, it really bugs us when we (or our guests) have to park accross the street. Similarly, in my lower-middle class neighbourhood, I have stopped seing these signs: "2 br / 1 bth for sale for $425,000 - please do not disturb the owners."
The only sign of hope I've seen, is that non-residential investment has gone up in december, first time in a long while. That's good but I don't know to what degree we should think from this that firms now have to start updating their obsolete machinery, given general excess capacity. Cuba has shown us how long one can survive on an obsolete stock of capital :-)
Besides, the weakening of the dollar is good news. In short-term though, it's likely to make the trade deficit worse via J-curve effects. Depending on how long lasting it is, the first effects should be felt next year around the same period. But this an exchange rate...
in my lower-middle class neighbourhood, I have stopped seing these signs: "2 br / 1 bth for sale for $425,000
That's what a 2 br / 1 bth flat in a so-so building goes for in NYC. Are you saying that price is high or low?
I was in Santa Cruz, CA this week, where I saw a 2br-1ba offered for $638K. (It did have a somewhat large lot.) Prices are still rising around here.
But a realtor told me that almost all the buyers right now are "investors" - who are not real estate investors, but are just people looking for a place to put their cash where it will "go up."
"Investors." I can't think of a worse sign. I think it won't be long now before the housing bubble bursts.
I will go on record predicting an economic boom once we push Saddam Hussein out of power. If nothing else, oil prices should drop significantly. Our actions will intimidate the Islamic militants and make the world safer for all. Moreover, the European nations other than the idiot Germans and French will most likely become closer to us.
The invasion of Ira will probably take place at the end of February--and will be over no later than the middle of March. What about the enormous costs associated with “nation building?” Once again, the lower oil prices will resolve this matter.
Swell--a "powerful negative external shock ... will hit a stalling U.S. economy, and it is more likely than not to push it into recession."
And then the Bushies will say the recession isn't due to their policies, but because of the shock, much the same way they were able to point to 9/11 during the previous recession.
>>That's what a 2 br / 1 bth flat in a so-so building goes for in NYC. Are you saying that price is high or low?<<
This is not San Francisco, the city itself, but accross the bay, about an hour commute away to the financial district. We're not on the hills, and it's not a quiet block, our district has relatively bad High Schools (next door they have great public High Schools, courtesy of Golden Gate Fields and their customers). In the Bay Area as a whole, home prices and rents have already come down a bit. It's not a crunch, but what I think is the beginning of a slow compression that a shock could turn into a burst.
P.S. DT is on record, good for him, but please please no drift into a discussion of the war on Iraq.
I'm not being obtuse. Are you saying that price is low/down? And what are Golden Gate Fields?
No one here in NYC sends their kid to a regular public high school if they can avoid it, BTW. There are a couple of magnet/admission-by-test jewels, but the "neighborhood" school is often awful.
I am saying prices are as high as they will get in my neighborhood for the foreseeable future and sliding.
Click here for more info about the Golden Gate Fields... Gambling = Taxes. And not of trouble when it's on the other side of the freeway, far from sight from well-thinking folks.
But, what I am also arguing is that I don't live in a particularly hot neighborhood. Next door, Albany, home of the GGF, offers excellent public schooling which attracts households with kids in schooling age, and thus damps housing prices in neighbouring districts.
"P.S. DT is on record, good for him, but please please no drift into a discussion of the war on Iraq."
That's absolutely impossible. The American economy hinges on the outcome of the war with Iraq. Morevover, the economy of the whole world is impacted.
Albany, home of the GGF, offers excellent public schooling which attracts households with kids in schooling age, and thus damps housing prices in neighbouring districts.
Of course, Albany's good schools don't hurt neighboring towns. The neighbors just can't offer what Albany can, and therefore don't attract families. If anything, homes on Albany's outskirts likely trade cheap because of undesirable neighbors, not the other way around.
This is part of the idiocy of having school funding/access tied to property taxes and place of residence.
Of course, you could look upon this as an opportunity to buy "a dip" in California's notoriously cyclical real estate market, exploiting today's low interest rates.
And now, I will go on record with two predeictions: A sluggish economy going into 2004 will embolden the Left to tout borrow, tax and spend, while assailing Bush's administration as a failure. And if the economy does improve, the Left will claim that the gains are maldistributed, thus jusitifying regime change in DC.
If only I could make money on these lay-ups. :)
“Saddam Hussein marched into Kuwait in early August 1990, and oil prices shot up. They briefly pierced the $37.50 threshold for four weeks in late September and early October before receding sharply thereafter. But by then the damage had been done -- a stalling economy had been hit by a shock. And the recession of 1990-91 was under way. “
There’s one major difference that Stephen Roach didn’t mention this time around. The United States and its allies are going to finish the job! This will inevitably calm the markets and bring down oil prices. Furthermore, the Islamic militants will be intimidated and become less of a threat. No, Roach is wrong---we will minimally have a decent size economic boom.
There is already plenty of evidence that prices are going down in the U.S. at the top end of the housing market:
here and here.
When I was back in the U.S. last week, I remember watching some news channel where an "average" man-on-the-street made the comment, "What could happen to housing prices? Go down 10? 20%?", with the idea being that, since housing prices "can't" go down more than 20%, housing is much safer than the stock market and so the obvious place to invest. Well, such comments are usually a screaming signal to sell, and a pretty good indication that housing prices are going to tank far more than 20%.
Only 14% of households in San Francisco can afford to buy a home. Same in my country, Contra Costa. Of course, some of it has to do with various limits to construction, legal, geographical and otherwise. But a lot of it has to do with housing speculation. My point? Well, when rents cannot square with house prices anymore you know you are in a bubble. Rents have actually been going down in my county, I am thus expecting house prices to keep sliding.
Note: if the government starts to sell bonds to finance the war, that will alsmot automatically translate into higher interest rates (gotta raise the return to generate the extra demand for bonds). Exactly the type of shocks that is likely to prick this bubble.
[End of case study]
Only 14% of households in San Francisco can afford to buy a home
So 86% of the homes for sale go unbought?
The US has a strong kink in its tax code, the deductability of mortgage interest, that distorts/elevates housing demand. Yes, it is a subsidy for the middle/upper class, that I think is obscene. It is purely a giveaway to the real estate biz, and other nations are quite nicely housed without such a tax benefit.
Also, the history of inflation manifests itself in buyers' calculus, making many prefer owning to renting even if the short run cash flow comparison doesn't seem to make sense.
"The US has a strong kink in its tax code, the deductability of mortgage interest, that distorts/elevates housing demand."
The argument about the housing bubble centers around comparisons with historical prices and ratios. Mortgage deductibility hasn't changed in recent years so it shouldn't bear on the argument.
Very interesting information about real estate investors. It's generally below my intellectual radar screen but the book "Rich Dad, Poor Dad" argues that investing real estate is in all circumstances (yes, in all circumstances) a better investment than the stock market because of both volatility and appreciation. That's a ridiculously unsophisticated argument but the book is a best-seller. It may be one of those telltale signs of a bubble.
Also, whenever you hear the argument that paying any price is OK because a given asset will always go up (so reminiscent of what was being said of IT stocks in '99-'00), it is time to flee for the hills. My wife and I are going to continue to rent for the foreseeable future.
Mortgage deductibility hasn't changed in recent years so it shouldn't bear on the argument.
Yes, but. At current low interest rates, the deduction makes the "real" cost of real estate borrowing NEGATIVE if the property appreciates a mere 3%/year, a pattern still seen in parts of the county.
Getting "paid" to borrow CAN induce a bubble. The Japanese called it "zai-tech" during their stock bubble.
So 86% of the homes for sale go unbought?
No, it means about 86% of 'em are renters. This has bad consequences for social cohesion, I think.