2006-01-28

America's Economic Slowdown

America's economy grew at an annual rate of just 1.1% according to figures just released.

We need to understand that this growth rate is quite low compared to growth figures of 3-4% recently. The low growth rate is a warning signal that things are getting a bit tight, but what will the future bring?

Economists are notorious in getting predictions wrong. One of the reasons why I gave up reading The Economist was that they predicted "stellar growth" in 2001 - only for a recession to hit. I myself have dabbled in economic prognostication and realise that I may end up with some egg on my face.

Nevertheless, the "vibe" I'm getting about the world economy, and the American economy in particular, is fairly negative. Because of that I will continue to make broad-based predictions about what will eventually happen, without getting too specific about when.

In a way I'm hedging my bets. This period of low growth could simply be a small hump that will be ironed out by improved rates of growth as the year progresses, or it could presage an economic slowdown or even recession in the near future.

I'm hoping that it will be a recession.

I mean that. I actually do hope there will be an economic slowdown, a rise in unemployment and an increase in personal and corporate bankruptcies. Does this make me evil?

You see, I'm of the opinion that America's economy is imbalanced. Debt levels are just too high, personal savings rates are just too low, the federal budget deficit is just too big, oil production is just too tight and the American consumer is just too contented. In other words, the conditions are actually quite bad.

An economic slowdown / recession is both the result of and the cure for an imbalanced economy. The reason why I am hoping that a recession will occur this year is simply because, if it doesn't, then the recession is postponed. Moreover, the recession that eventually will hit will be much worse than if it occurs sooner. If the pain of the future is brought forward to the present, we can deal with it better.

Commentators have linked the current slowdown with the impact of post-Katrina oil prices. Although there is some truth in this, we need to remember that prices were already quite high in the months before Katrina. Moreover, the price of oil as I type this is is between $67 and $68 per barrel - near the levels experienced in September after Katrina damaged oil distribution infrastructure in the Gulf of Mexico. The reason this time is, ostensibly, because of the heightened threat posed by Iran's nuclear weapons program, but is probably more due to production shortages caused by a drop in Light Sweet Crude extraction.

While it is obvious that the world economy has managed to "shrug off" much of the increases in oil price, a point would naturally be reached where it would begin to affect economic growth rates. Moreover, high oil prices affect longer-term economic growth, which means that high prices now affect economic growth in the future. The tepid growth of the US economy in the last quarter is probably due to both the immediate Katrina shock and the longer-term effects of high oil prices preceding that.

But I'm not willing to lay money on a recession beginning next quarter - while I think it is likely there is just too many variables to make accurate predictions. America may, in fact, continue their debt binge for another year, promoting growth but, eventually, being set up for an even bigger fall.

So while there appears to be two choices - recession or return to a debt-binging growth - there is actually a third outcome: "economic stagnation". By this I don't mean a recession, but a long-term period of low growth, where the economy is expanding at a reasonably slow rate on a continual basis. This is actually my preferred outcome, but will require tighter than normal monetary policy by the Federal Reserve. Faced with an upcoming recession, the Fed may be tempted to drop interest rates again. I think that this may be the wrong move - certainly monetary policy may require loosening, but I think the inflation target needs to be lower than what it is now. Higher interest rates will encourage private saving and kerb domestic spending - both of which will lead to a reduction in debt levels and a re-balancing of the current account. Hopefully this rebalancing will lead to higher levels of consumption in America's trading partners such as Japan and China, which should reduce the trade deficit and, especially in the case of China, rely more upon their own vast domestic consumption as the engine of their economy rather than relying upon the US.

I think the world economy is going to enter a unique period where America's consumption is going to be responsible for less and less of international economic growth. I think countries like America, as well as Britain and Australia, have come to the end of their standard economic systems. Both America and Australia need to address their current account deficits, and the coming period of instability will be a result of, as well as the cure for, the current mess. Still unknown is the effect of Peak Oil and the predicted oil shortage that will come in the next 5-10 years, something that will cause oil prices to rise ever higher, if not the cause of the current rise.

Whatever happens, it will certainly not be boring.

From the Osostrian School Department

© 2006 Neil McKenzie Cameron, http://one-salient-oversight.blogspot.com/

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2 comments:

Dave Lankshear said...

Hi — nice to see the grand peaknik tradition continue, even if it was in Semaphore (very quietly signalled. ;-)
I'd like a full air raid siren for peak oil, but each to their own style.

I thought I'd just add this extra summary of peak oil to explain the 3 reasons oil "post-peak" will be remarkably different to pre-peak.

Peak oil is the year oil production “peaks” or reaches maximum output. It is the year we pump the most oil we ever will. It is the half way mark. The first half of the oil age was what some have called “easy oil”.

That era is almost over. We have burnt all the cheap oil, and after the peak we enter the age of vastly more expensive oil. Oil will cost more to mine, refine, and sell.

1. Mining difficult oil costs more — instead of Texan plains we now mine expensive deep-sea beds.

2. Refining inferior oil costs more — the age of sweet oil is turning sour.

3. Selling less oil costs more — supply will not meet demand, driving the price up.

In other words, oil is about to become difficult, dirty, and dwindling.

“Humanity’s way of life is on a collision course with geology — with the stark fact that the Earth holds a finite supply of oil…

The peak will be a watershed moment, marking the change from an increasing supply of cheap oil to a dwindling supply of expensive oil.”
National Geographic, June 2004, page 88.

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