Recession watch: 2007

Compare and contrast. First, the “soft landing” view, from Carlos Leitao, Chief Economist of The Laurentian Bank, as quoted in the Globe and Mail:

[T]he Canadian economy is in the midst of ”a significant slowdown that we still think should be relatively short-lived. Nevertheless, the downside risks are important and far outweigh upside risks.”

[T]he U.S. economy ”has proven to be remarkably resilient, despite the relentless focus on downside risks. The (U.S.) economic slowdown remains well-contained, with housing and automobile assembly the only main areas of weakness.”

… ”Nevertheless, this slowdown is more arithmetic than reflective of an underlying economic event,” Mr. Leitao said in a release. ”In fact, we expect economic growth to gradually accelerate throughout the year, with the (U.S.) economy returning to potential by the fourth quarter of 2007.”

Second, the “not-so-soft landing” view, from Joseph Stiglitz’s most recent column:

[A] slowing US economy constitutes another major global risk. At the root of America’s economic problem are measures adopted early in Bush’s first term. In particular, the administration pushed through a tax cut that largely failed to stimulate the economy, because it was designed to benefit mainly the wealthiest taxpayers. The burden of stimulation was placed on the Federal Reserve Board, which lowered interest rates to unprecedented levels. While cheap money had little impact on business investment, it fuelled a real estate bubble, which is now bursting, jeopardising households that borrowed against rising home values to sustain consumption.

This economic strategy was not sustainable. Household savings became negative for the first time since the Great Depression, with the country borrowing $3 billion a day from foreigners. But households could continue to take money out of their houses only as long as prices continued to rise and interest rates remained low. Thus, higher interest rates and falling house prices does not bode well for the American economy. Indeed, according to some estimates, roughly 80% of the increase in employment and almost two-thirds of the increase in GDP in recent years stemmed directly or indirectly from real estate.

Making matters worse, unrestrained government spending further buoyed the economy during the Bush years, with fiscal deficits reaching new heights, making it difficult for the government to step in now to shore up economic growth as households curtail consumption. Indeed, many Democrats, having campaigned on a promise to return to fiscal sanity, are likely to demand a reduction in the deficit, which would further dampen growth.

Meanwhile, persistent global imbalances will continue to produce anxiety, especially for those whose lives depend on exchange rates. Though Bush has long sought to blame others, it is clear that America’s unbridled consumption and inability to live within its means is the major cause of these imbalances. Unless that changes, global imbalances will continue to be a source of global instability, regardless of what China or Europe do.

In light of all of these uncertainties, the mystery is how risk premiums can remain as low as they are. Especially with the dramatic reduction in the growth of global liquidity as central banks have successively raised interest rates, the prospect of risk premiums returning to more normal levels is itself one of the major risks the world faces today.


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