Just as the US economy strengthens, other countries threaten to drag it down. Employers in the US are creating jobs at the fastest pace since the late 1990s and the economy finally looks ready to expand at a healthy rate.
But sluggish growth in France, Italy, Russia, Brazil and China suggests that the old truism “When the US sneezes, the rest of the world catches a cold” may need to be flipped.
Maybe the rest of the world will sneeze this time, and the US will get sick.
That’s the view of David Levy, who oversees the Levy Forecast, a newsletter analysing the economy that his family started in 1949 and one with an enviable record. Nearly a decade ago, the now 59-year-old economist warned that US housing was a bubble set to burst, and that the damage would push the country into a recession so severe the Federal Reserve would have no choice but to slash short-term borrowing rates to stimulate the economy. That’s exactly what happened. Now Mr Levy says the United States is likely to fall into a recession next year, triggered by downturns in other countries, for the first time in modern history.
“The recession for the rest of the world … will be worse than the last one,” says Mr Levy, whose grandfather called the 1929 stock crash and whose father won praise for anticipating turns in the business cycle, often against conventional wisdom.
Mr Levy’s forecast for a global recession is extreme, but worth considering given so much is riding on the dominant view that economies are healing. Investors have pushed US stocks to record highs, and Fed estimates have the US growing at an annual pace of at least 3 per cent for the rest of the year, and all of 2015. Investors have also poured millions of dollars into emerging market stock funds recently, on the hope that economic growth in those countries will pick up.
Worrying signs are already out there. European banks are still stuck with too many bad loans from the financial crisis. Household and business debt there is too high.
In China and other emerging markets, the old problem of relying on indebted Americans to buy more of their goods each year and not selling enough to their own people, means a glut of underused factories.
“The world hopes to ride on the coat-tails of the US consumer,” says Eswar Prasad, an economist at Cornell University, “but the US consumer isn’t in a position to take on the burden.”
Emerging markets bounced back faster from the financial crisis than did rich countries, but Mr Levy thinks a big reason for that has made things worse. Overseas companies ploughed money into factories, machines and buildings used to make things on the assumption that exports would grow at a pre-recession pace. They have not – a big problem since companies had been expanding production before the crisis, too.
Compared to such fragile economies, Mr Levy says the US is in decent shape. Like most economists, he’s not worried about the nation’s 2.9 per cent drop in economic output in the first quarter, attributing it to harsh winter weather. He expects growth to return, but not for long, as a recession in either Europe or emerging markets spreads to the US.
He says the US is more vulnerable to troubles abroad than people realise. Exports contributed 14 per cent of US economic output last year, up from 9 per cent in 2002. That sounds good, but it also makes the country more dependent on global growth which, in turn, relies more on emerging markets. Those markets accounted for 50 per cent of global output last year, up from 38 per cent in 2002.
Mr Levy predicts a US recession will throw its housing recovery in reverse, and push home prices below the low in the last recession. He says panicked investors are likely to dump stocks and flood into US Treasuries, a haven in troubled times, like never before.
His forecasts may seem a bit much, but Mr Levy’s family has a good record of running against the crowd.
His grandfather, Jerome, didn’t just call the great crash of 1929 – he sold his stock and liquidated his wholesale goods business in anticipation of it. Immediately after the Second World War, when many experts thought the US was sure to fall into another depression, his father, Jay, accurately predicted a rapid expansion. In late 1999, his uncle, Leon Levy, a hedge fund manager and collector of antiquities, invited me into his office and predicted a new generation of the wealthy would be laid low soon in a coming dotcom crash.
Those stocks began their long dive a few months later.
For all the prescience from this latest Levy, he thinks the origin of the world’s economic malaise is far more complex and deep than investors focused on the housing collapse think. The problem is not just that people in the US took on mortgages they couldn’t afford, but too much borrowing of many kinds in many countries, and by businesses as well as individuals. This build-up of excessive debt started so long ago – Mr Levy dates it to the 1980s in the US – that people no longer know what’s prudent.
Many economists, for instance, are impressed that debt held by US households has fallen from 130 per cent of annual take-home income before the crisis to 104 per cent, suggesting that people aren’t borrowing too much. But what is a healthy level? Mr Levy is not sure, but he’s suspects it’s a lot lower, noting that, in 1985, it was 74 per cent of people’s income.
Whether all this means a US recession is a different matter. Steven Ricchiuto, the chief economist at Mizuho Securities, also thinks people are missing signs of a coming global slowdown, but that the US economy will continue to grow anyway. And Mr Prasad, who sees many of the same problems as Mr Levy, suspects emerging economies may be “bottoming out,” suggesting investors buying their stocks now might not be so stupid after all.
Still, Mr Levy has proved more right than wrong lately. For a year now, some experts have been expecting a surge in corporate spending on factories, machines and equipment in rich countries where it had lagged, and a continuation of strong spending in emerging markets. That would speed growth because such capital expenditures, even if wasteful, add to gross domestic product. But Mr Levy says too much has been spent on expanding capacity and the optimists are wrong. Last month came proof: a Standard & Poor’s report showed capital expenditures, adjusted for inflation, dropped by 1 per cent globally last year, and by 4 per cent in emerging markets.
That may be healthy in the long run. But as China tries to contain the fallout from a deflating real estate bubble, India grows at its slowest pace in a quarter century, Brazil teeters on recession and Russia may have already sunk into one, the timing is awful. Last week there was bad news from the eurozone: industrial production fell 0.5 per cent in the year to the end of May, suggesting even the modest recovery there might be stalling.
You don’t have to buy Mr Levy’s gloomy predictions to see the world may be at a worrying crossroads.