Sunday, October 01, 2006

Who Will Take Up the Slack If the U.S. Goes Into a Recession?

Recent indicators have fairly consistently (with the Chicago PMI being the only real anomaly) showed that the U.S. economy is slowing, and there is a strong case for believing that a recession is underway soon.

The question now is, if that happens, how will this affect the world economy? The rest of the world have become increasingly dependent on exports to America, but a recession there would end the trend of increased net exports to America from the rest of the world and indeed see it partially reversed for three reasons: 1) The direct effect of a recession will be a decline in demand, including a decline in demand for imported goods 2) A recession will mean that interest rates in America will fall compared to the rest of the world, something which in turn will mean a weaker dollar which in turn means that the decline in demand will disproportionally hit imports 3) A recession increases the likelyhood of protectionist legislation in Congress, which will have a similar effect as the weaker dollar.

This will undoubtedly mean that growth in the rest of the world will be lower than it otherwise would have been, but this does not necessarily mean that growth will be lower than today as other factors could compensate for these negative effects.

However, looking at other mayor economic regions, it does not appear promising.

Europe is currently undergoing a cyclical recovery and as this upswing is in its early stage it could have potentially continued for a few years more. But Europe's structural weakness will mean that growth in absolute terms will not be strong. Moreover, the planned German VAT hike will have a strongly negative effect and will at best mean that growth will slow. In the worst case scenario, it could in combination with the U.S. recession send Germany into a recession, which would have greatly negative effects for the rest of Europe too.

The centre-right electoral victory in Sweden will for reasons explained here
lower the Swedish current account surplus and thus help global re-balancing, but ultimately Sweden is too small to make a really significant difference.

Japan is in an ideal position in the business cycle and could therefore see some cyclical upswing, but Japan's structural weaknesses (mainly related to its demographics) and its mercantilist economic strategy means that growth will in absolute terms not be particularly and that it will not be able to contribute much to global re-balancing.

China is extremely strong when it comes to its structural growth rate. But its reluctance to allow the undervalued yuan to significantly rise in value have left it overly dependent on exports to America and have sabotaged the needed shift to domestic demand. The U.S. recession will likely mean that the Chinese trade surplus will fall, but this will unfortunately not translate into a higher growth in domestic demand, but rather in a cyclical slowdown.

All of the above mentioned economic powers will be helped somewhat by the likely fall in commodity prices caused by falling demand from America, but this will be of only a limited significance.

Commodity exporters will suffer as their export earnings fall. However this will only be of limited significance to domestic demand there as most commodity exporters (particularly oil exporters) have had a deliberate strategy to use the windfall profits to buy foreign equities rather than to allow it to translate into increased domestic demand. This should mean that they fairly painlessly could contribute to global re-balancing.

The conclusion however remains that the negative effects for the rest of the world from a U.S. recession will not be counteracted by other positive factors. The small positive effects from lower commodity prices and the Swedish centre-right victory will likely be cancelled by the negative effects of the German VAT hike, meaning that economic growth in the rest of the world will fall if the U.S. recession.


Post a Comment

<< Home