US Slowdown/Recession and its Repercussions

Is it a slowdown or a recession? Is it a slowdown leaping towards recession? Is it a recession deepening to become a depression? Is it just a natural cycle of slowing down economic activity? Well, there are way too many opinions and economic pundits worldwide are divided in their degree of pessimism. No matter what it turns out to be, it’s definitely an opportunity for doomsayers to earn some money. Since 2000, US slowdown never went out of fashion anyways and there have been noises all through the decade announcing it’s round the corner. Irrespective of the brouhaha, there were three troublesome spots on the horizon:

• Large and growing current account deficit (hovering well above 5% of GDP.) This simply means that the country is borrowing from abroad to finance the gap between imports and exports of goods and services. Further, the quality of this deficit has been worsening - the money borrowed was increasingly being used to finance imports for consumption vs. being deployed for growth.




• The real estate bubble. The real estate prices in some parts of the country spiraled up without any good rhyme or reason. There was not enough economic activity impetus to justify very high prices. This led to unnatural property valuations (and subsequently, large mortgage loans, which became ‘sub-prime’ when property prices crashed.)




• Spurt in sub-prime loans. Financial institutions distributed loans like never before to anyone and everyone creating a largely credit driven spending. This created a mess when people started defaulting on these loans. Some investigation needs to be done to find out why banks went on an overdrive to give a loan.

So a correction to rebalance the economic equation was overdue. However, whether it will result in a full blown recession or depression is yet to be seen. Also, since economies of world are so tightly integrated now that any change in one parts creates immediate ripples across the world, this may act either as a shock absorber or as a single ignition point of to detonate the large part of world economy. Earlier recessions had a regional flavor but this time that does not seems to be the case.

Another important point to note is that since US is a largely consumption driven economy, most of the slowdown is very negative sentiment driven. This phenomenon has troubled the economists no end and none of the fiscal or monetary measures taken by Fed chief Ben Bernanke or his predecessor Alan Greenspan have succeeded in stimulating higher consumption in US. The phenomena definitely created space for some Nobel laureates though but so far no one knows how to induce higher consumption by American people. Maybe consumption levels have saturated and can not go up any further. Economists need to find other levers to stimulate the American economy.

I sometime wonder if recession is really an economic phenomenon - it seems more econo-psychological - you talk more about a possible recession and it will arrive. That’s what seems to have happened this time - for over a year, everyone who is anyone in financial market has been talking about a possible recession in US and it seems to have arrived. The reason is simple - as US is a very consumption driven economy and if people stop, slow down or postpone spending, it creates a vicious negative feedback loop for economy (less spending >> high inventories >> price crash & output reduction >> layoffs >> defaults on loans >> strain on banking system >> less spending >> and the cycle continues!) If I am a consumer convinced by innumerable financial wizards that US is going into recession and people will loose their jobs, my basic instinct will be to cut down on spending and save every penny I can for that possible rainy day. And I have started a downward spiral - the less I spend, the more economic activity slows down, the more the doomsayers talk and I cut down on my spending even more. Gentlemen, you have created recession out of the blue!

But not everything is lost here - the economic indicators are inconclusive on whether the US is in a recession or not (indicators like unemployment claims, unsold inventory levels, quarterly corporate results, price stability, inflation, etc. are mostly a mix bag not showing any special favor.) Further, US has many structural features to make a recovery faster and there is no political paralysis to put spanner in the recovery engine.

Let’s all talk about recession being over and it will run away!

Back to top