Hamish McRae: Americans are in for tough times, even if the Fed won't (yet) say it

US consumers are quite close to a tipping point, where they collectively decide to stop spending
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The Independent Online

Even the shortest visits to the US tell you things about the economy that you would not get from the figures. While this university town might seem to be sailing comfortably along, it is only an hour from Detroit, home of the US auto industry.

The American education industry remains in pretty good shape but the car industry most certainly is not. The talk is about globalization and the energy squeeze but the practical impact of both is being felt in jobs and most particularly in property prices.

For there is a huge imponderable in the US at the moment: will the stalled housing market spread through into a stalled consumer boom? If it does, then a recession in the early part of next year will loom. If not, then the present growth phase will end in a "soft landing". The figures so far are ambivalent, but what a visit has brought home is that some parts of this huge country will certainly experience recession, even if the overall numbers say one hasn't happened.

The housing story can be swiftly told. Price inflation in housing had been running at close to 10 per cent a year but in the past few months this has ground to a halt. The supply of new homes on the market has shot up and is now equivalent to ten months' sales (first graph).

The number of housing permits, which had been rising steadily since the early 1990s - and which did not turn down significantly during the 2001 recession - has suddenly fallen (second graph). And inflation for existing homes is now zero, maybe negative (final graph).

It is actually quite difficult to get up-to-date figures for house prices in the US, but I gather from a paper by Commerzbank that one of the more reliable series comes from the Office of Federal Housing Enterprise Oversight. In the past 30 years this has never turned negative, though in real terms it fell in economic downturns of the early 1980s and early 1990s.

Some calculations by the bank suggest outcomes somewhere between prices being flat in real terms to a fall of 5 per cent in real terms. That would be less serious than the house price deflation in the UK in the early 1990s, and the bank concludes that a decline in housing activity likely to provoke a recession next year is unlikely at present interest rates. So, a soft landing.

That is still the majority view on Wall Street and at the Federal Reserve. Minutes out this week from the last meeting, when the Fed held rates instead of increasing them as it had done steadily over the previous two years, confirm that it expects a slowdown next year. Specifically it thinks there will be 18 months of below-trend growth but nothing worse.

But then they would say that, wouldn't they? It is very hard in the context of the public debate for mainstream forecasters to predict recession. For the Fed to do so, given its authority, would almost certainly be to provoke one. If you are seeking the opposing view you have to go to the mavericks.

One small independent forecasting unit that had not previously come up on my radar is the Economic Cycle Research Institute (ECRI). It was one of the very few organizations in the US to predict the 2001 recession and its views now have just been reported in the New York Times.

The ECRI does not yet call a recession but it is concerned. It thinks that the last six months show similarities to two situations. One is the run-up to previous recessions; the other to the gentle slowdowns that took place in the middle of the cycle in the 1980s and 1990s. At the moment it feels it is too early to decide which way things will flip.

This notion that it is evens whether there will be a recession next year, while much more gloomy than the mainstream position, feels to me to about the right judgement at the moment. In another couple of months we will know much more.

Meanwhile consumers are worried. The economic forecasting unit, the Conference Board, found that consumer confidence in August was at its lowest since November last year. You would expect that. The issue is the extent to which a lack of confidence translates into lower purchases. The evidence is consistent but not conclusive, but the danger is there.

The questions that follow are whether this danger is fully understood by the rest of the world and whether US policy could respond effectively if and when the danger of recession becomes more apparent. I think the answer to both is "probably not".

You have to remember that the world economy now is very different to the world economy during the run-up to the last US recession in 2001. Most obviously, China is much more important in terms of incremental demand, while Europe is much less important.

But China is very dependent on the US market to maintain demand, much more so than Europe ever was. China would ride through a US recession by switching output to the domestic market, but the shock would linger. What concerns me is that there is really very little folk-memory in China of a US recession - even the one in 2001 was a very mild one.

As for the US response, the Fed would stop increasing rates but its ability to start cutting them is very limited. Inflation remains high relative to money interest rates, at least by historical standards. Real interest rates are still only about 2 per cent. If real rates at 2 per cent are enough to stop the economy, that tells you that an awful lot of people are over-borrowed.

Yes, in extremis, the Fed can cut rates. Were there some kind of financial crash that is what central banks do. But trimming rates when inflation is above 3 per cent is not really credible. Indeed were it to cut short rates there would be a danger that long rates would move upwards and long rates are extremely important for housing finance.

Monthly payments matter. They matter to many people in Britain, of course, but I think they matter more in the US. They crop up in casual conversation - in a chat with the immigration official at Detroit airport, for example - in a way that they don't quite dominate things in Britain.

My overriding impression is that that the US consumer is quite close to a tipping point, a point where collectively he or she will at last decide to slow down the growth of spending and maybe start to cut back. In Detroit I guess that has already happened.

That would indeed point towards recession. But set against that another thought. It is that economies are like supertankers and America's is more "supertankerish" than any other. Things change quite slowly; momentum takes a long time to lose pace. If the "recession next spring" view is wrong, it will be because of that momentum.

But then, you say, how will the US cope with a long period of slower growth, little or no rise in house prices and still-high energy costs? Americans are in for tougher times, and I think they know it.