3 Reasons Why the U.S. Will Avoid a Recession: I'm Skeptical

It was refreshing to read Anatole Kaletsky's contrarian piece in yesterday's London Times; it should be required reading for all investors. "I am probably the only economist left in the world who still believes that a U.S. recession is likely to be avoided," says Kaletsky. Given the massive amount of doom and gloom in the financial press, it's important to try and understand the contrarian argument.

The core of Kaletsky's argument is that we're only seeing sector-specific slowdowns in the U.S., and that "problems affecting only one or two parts of the economy are a continuous feature of any market economy with its constant variations in demand and supply for particular products and services." But surely the financial and housing crises in America are now so severe that there can be no hope of avoiding a self-sustaining downward spiral? Kaletsky disagrees, and offers three reasons for continuing to resist the consensus view:

1. "First, the occurrence of a severe financial crisis is not, in itself, a sufficient reason for expecting a recession. In fact, there have been severe financial crises that did not lead to recessions in the middle of every previous economic cycle: for example, the Latin American defaults of 1984, the stock market crash of 1987 and the savings and loan and housing collapse of 1988-89 and the Mexican peso, Asian and Russian crises of 1995-98."

2. He believes "powerful expansionary forces are about to come into play in the U.S. economy in the months ahead." Kaletsky believes that the U.S. tax rebate will have a meaningful impact. "Even if only half this money is spent, U.S. consumption will therefore be guaranteed to grow by at least 3 per cent in the third and fourth quarters. And beyond that, the lagged effects of the Fed's recent monetary easing will kick in from the start of 2009."

3. He believes that the end of the U.S. housing downturn is in sight, citing affordability statistics. "U.S. house prices have already fallen almost 15 per cent from their peak and as a result property in America is no longer expensive in relation to average incomes," he says. "For example, the National Association of Realtors' composite affordability index stands at 135, compared with a record high of 140.8 reached in 1999, at the start of the recent housing boom."

Mr. Kaletsky's argument sounds great, but it fails to show how a fragile U.S. economy will be able to cope with an unexpected, external shock. America is bankrupt and does not have sufficient savings to absorb future shocks. Foreigners will have to step in and save the day, but the plummeting greenback make U.S. assets look like falling knives. What happens if a collapsing dollar forces the Fed to raise interest rates to entice foreigners to buy the government bonds that finance the U.S. deficit? The Fed is running out of ammunition, further limiting its ability to effectively cope with future problems.

As much as I want to believe in Mr. Kaletsky's point of view, I have to admit that his case only scratches the surface. Call me a doom and gloomer if you like, but I believe that the current crisis is a symptom of a deeper cause, and Mr. Kaletsky's arguments are interesting but irrelevant. This could be the end of credit expansion based on the mistaken belief of market fundamentalism, and now is not the time to argue about the semantics of recession.

Comments

[StupidityAn...:]

What idiotic nonsense. The more aggressive people get as they bang the table and proclaim everything is OK the more obvious their panic becomes. Thou dost protest too much !

2008 Apr 07 03:41 AM

[StupidityAn...:]

Oops, didn't notice that the author doesn't buy the 3 "reasons". Good call.

2008 Apr 07 03:43 AM

[Maniac in M...:]

You bring up good points. We don't have savings to absorb any more shocks. Foreigners are evidently not inclined to buy more US assets, and we should be fearful that we begin seeing outflows of T-bill securities.

Moreover, the guy writing that article misses the point. The rally recently compensated for passing over the crisis. What's still priced into the market is decelerating cash flows from losses of jobs. Less jobs available, less income, less cash flow to pay debt.

The expansionary forces assume we still are irrationally exuberant to buy more Garmin GPS units for all out friends. With the news tossing out the R-word and the F-bomb (foreclosure, people) on a nightly basis, it's pretty safe to say consumers are more carefully watching how they spend their money right now.

The affordability index naturally assumes current incomes and cash flows. And you know what happens when you assume. If jobs are declining, overall incomes are declining, and the affordability index rises. We evidently won't see that change until the National Association of Realtors stops saying, "It's always a good time to buy a house," and revise the median income they use to calculate their indices.

2008 Apr 07 04:22 AM

[Chris Marshall:]

I think that the consumers are more likely to save their refunds, as a backstop for their mortgage payments, rather than go out and spend it.

I saddens me to think that some people will spend their rebate in a foolish manner, but generally I believe that consumers are more sensible than the market gives them credit for.

I believe that most consumers will not move back in to equities or bonds, for a considerable time, as they have lost faith in the banks, and the Governments ability to control them.

2008 Apr 07 04:43 AM

[Scared Stiff:]

Furthering the contrarian view of this contrarian view, common sense says that this housing crisis won't end until, at the very least, the tidal wave of ARM resets passes. That's the best possible scenario. A $1500 government handout is going to pay very many months of a $400,000, 12% mortgage.

2008 Apr 07 06:28 AM

[Jason Rines...:]

You got it Scared Stiff. While the official recession may be short, the recovery is going to be long and painful. Housing has not reached bottom and when it does, many new homebuyers will enter the market and those foreigner's bailing us out won't happen until corporate balance sheets look healthier (and homes bottom out). I believe the bottom will be mid-2009 and will be a buying bonanza for those of us who were fiscally responsible with cash to spend.

2008 Apr 07 10:27 AM

[Robert Burns:]

Only one way to see it and that is that a system that existed entirely on credit tried to exist by acquiring debt to grow larger. Guess what?
The bottom line is debt; that's all that was acquired and with no credit available to cover you don't get out of the hole you dug for yourself.

2008 Apr 07 02:08 PM

[bill d:]

I don't know what the "scraping content" warning is about but I guess it's OK for you to insert info from a bloggers site to put on yours. I'm sure everything on your site has been a totally original thought. Why don't you copyright or see if you can get the First Amenment overturned. I believe in a free exchange of information. Feel free to scrape this (and my comment)

2008 Apr 07 02:52 PM

[VSD:]

We won't have a recession simply because we talk about it so much. Once the rest of the world is convinced that dollar drop days are over, they will snap up US housing.

2008 Apr 07 06:18 PM

[dorvedor:]

Without some external shock such as a terrorist attack, it is possible
for the U.S. to avoid a prolonged recession. The rest of the world needs the U.S. and is therefore unlikely to take steps that will be
detrimental. The rest of the world, the BRICs, are growing at unprecedented rates. This has never happened before in the history of the world. This massive growth leading to almost a billion people
entering the middle class for the first time within a decade. That
will probably override the incredible stupidity in America's response to the energy crisis, the budget and trade deficit, the financial mess, etc. I do not own U.S. stocks except for those dealing with commodities b/c I don't see exceptional growth there but I
don't expect the U.S. to spiral downward forever.

2008 Apr 08 01:51 AM