Dan­ger for US that ex­pan­sion will evolve into re­ces­sion

The National - News - - IN DEPTH - NOAH SMITH Com­ment

Gen­eral Mo­tors just an­nounced the clos­ing of four fac­to­ries in the US and one in Canada.

Three of the fac­to­ries are in Michi­gan and Ohio – states that voted for Don­ald Trump in 2016, in part thanks to his prom­ise to bring back Amer­i­can man­u­fac­tur­ing jobs. So much for that.

GM has long been a trou­bled com­pany, re­quir­ing a govern­ment bailout in the Great Re­ces­sion and strug­gling to build pop­u­lar cars ever since. But the re­cent plant clo­sures may have a cause that goes be­yond GM’s board­room. Auto sales in the US have de­clined from their level of three years ago and have taken a con­sid­er­able drop from their peak in 2017 – and that’s even with petrol prices that have fallen sig­nif­i­cantly in the past few months.

Look­ing at his­tory, a clear pat­tern emerges – car sales tend to rise in the early stage of an ex­pan­sion, but peak and de­cline shortly be­fore a re­ces­sion.

There is ac­tu­ally a fun­da­men­tal eco­nomic rea­son why this should be true. Un­like non-durable goods and ser­vices such as food, heat­ing and in­sur­ance that peo­ple have to pur­chase even in bad times, con­sump­tion of durable goods such as cars and houses can be de­layed. If you’re un­em­ployed, or wor­ried about be­com­ing un­em­ployed, or if sales at your com­pany are bad this year, you can keep driv­ing your old car a lit­tle while longer, or put off buy­ing that new apart­ment.

As econ­o­mists Robert Barsky, Christo­pher House and Miles Kim­ball pointed out in a 2007 pa­per, putting off spend­ing on durable goods is a big part of what trig­gers a re­ces­sion. Lower auto and home sales are a con­se­quence of a bad econ­omy, but they also cause the econ­omy to get worse.

Hous­ing is usu­ally a big­ger fac­tor than cars. In an­other 2007 pa­per, econ­o­mist Ed Leamer ar­gued that res­i­den­tial in­vest­ment is the big­gest driver of the eco­nomic cy­cle. He wrote: res­i­den­tial in­vest­ment con­sis­tently and sub­stan­tially con­trib­utes to weak­ness be­fore … re­ces­sions…Eight of the 10 [US post­war] re­ces­sions [be­fore 2007] were pre­ceded by sus­tained and sub­stan­tial prob­lems in hous­ing.

Of course, one year af­ter that was writ­ten, the US had the big­gest hous­ing-driven re­ces­sion of them all.

Hous­ing has been par­tic­u­larly weak through­out the re­cov­ery from the Great Re­ces­sion, prob­a­bly be­cause Amer­i­cans bought so many houses be­fore the crash, and also prob­a­bly be­cause more young peo­ple are liv­ing longer with their fam­i­lies.

But even from this low level, in 2018 there has been a down­turn in new home sales. Hous­ing starts are at es­sen­tially the same level as 2016.

So with car sales in de­cline and new home sales low and fall­ing, the econ­omy looks to be on shaky foot­ing. But busi­nesses are still in­vest­ing en­thu­si­as­ti­cally.

All of this makes for a very strange ex­pan­sion. Why is busi­ness in­vest­ment hold­ing up, even as GM pre­pares to shut fac­to­ries and hous­ing fal­ters from al­ready-low lev­els?

It could be that they are plan­ning to ramp up ex­ports. But those don’t look par­tic­u­larly strong ei­ther.

With Mr Trump’s trade war hit­ting US ex­ports such as gas and agri­cul­tural prod­ucts, there seems to be lit­tle rea­son to ex­pect an over­seas sales boom in the near fu­ture.

One pos­si­bil­ity is that Amer­i­can con­sumer tastes are sim­ply shift­ing, as mil­len­ni­als trade cars for smart­phones and choose to live with their par­ents. Over­all con­sump­tion of durable goods is hold­ing up bet­ter than cars.

But an­other pos­si­bil­ity is that the US econ­omy has sim­ply hit the top of the cur­rent busi­ness cy­cle, and is headed for a down­turn. That is cer­tainly what Mr Leamer’s pa­per, with its em­pha­sis on hous­ing over busi­ness in­vest­ment as a lead­ing in­di­ca­tor of re­ces­sions, would sug­gest.

So is a re­ces­sion com­ing soon? Some of the pieces do seem to be fall­ing into place. Macroe­co­nomic in­di­ca­tors such as term and credit spreads have been look­ing shaky. Many ob­servers have been watch­ing the cor­po­rate-debt mar­ket, es­pe­cially BBB-rated bonds and lev­er­aged loans. If con­sump­tion fal­ters, cor­po­ra­tions that loaded up on risky debt could suf­fer a wave of de­faults. Mean­while, the trade war seems to be caus­ing un­pre­dictable and mostly neg­a­tive ef­fects, as com­pa­nies find it harder to pur­chase in­puts from over­seas, or they run into for­eign re­tal­i­a­tion.

Thus, a par­tic­u­larly strange ex­pan­sion may soon turn into a rather typ­i­cal re­ces­sion. That would be sad, be­cause it would mean that the big­gest trough in 80 years was fol­lowed by one of the most un­der­whelm­ing peaks.

That is a good ar­gu­ment for the Fed to hold off on rate in­creases to stave off this pos­si­bil­ity, and Mr Trump should think twice about con­tin­u­ing his trade war.

Newspapers in English

Newspapers from UAE

© PressReader. All rights reserved.