What About the 'R' Word?
With the house party ending, don't expect robust growth -- but a recession isn't likely
January 16, 2006
By Edward Leamer
UCLA Anderson Forecast
(Commentary published in the Los Angeles Business Journal)
In recessions we have negative economic growth, and in recoveries we rack up pluses.
But overall, the U.S. economy since 1970 has grown an average of a little more than
3 percent a year.
Don't expect that for 2006.
The Wall Street Journal, in a recent survey of 56 economists, found that their forecasts
for 2006 averaged around the "normal" rate of 3 percent. But that is not what the UCLA
Anderson Forecast projects.
The UCLA Anderson numbers are about 0.5 points less than normal. When the Wall Street
Journal ranked the forecasts top to bottom, highest to lowest, UCLA Anderson's forecast
ranks 52nd of 56.
What accounts for that difference? Part of the answer depends on our interpretation of
the stronger-than normal numbers in 2005 and 2004. Here is my story of the decade: It's
been a roller coaster ride that is ending in 2006.
The discovery of the Internet set off a mad dash for the Web, and that powered the U.S.
economy forward at breakneck speed from 1997 to 2000. Every business in America had to
have a cool Website or advertise on one. There was a very heavy investment in equipment
and software. Every person who could crawl off the street was offered a job and anyone
who could whisper "yes" was given one. Equity values went into the stratosphere and dot-com
workers and their friends celebrated with a wild spending spree.
Reality and reason became unwanted guests at this party in 2001, causing equity values to
plummet and jobs to disappear.
But the party picked up again in 2002, when Alan Greenspan arrived with a very attractive
bond market nestled on his arm, and passed out party favors inthe form of low-interest loans
to compensate for the loss of equity wealth.
The low loan rates, reminiscent of the 1950s, set off a mad dash for homeownership that powered
the U.S. economy forward at breakneck speed from 2002 to 2005. Every American family had to
have a cool house or live next to one. There was heavy investment in new homes and remodeling
existing ones. Every person who could crawl off the street was offered a home loan and anyone
who could whisper "yes" was given one. Home values went into the stratoshpere and homeowners
and their friends celebrated with a wild spending spree.
But as the party went on, Mr. Greenspan began to grow worried over the level of debt, and reality
and reason returned. In 2006, regulators, worried about delinquencies and defaults, will start
to require borrowers to walk off the street (crawling is not enough anymore) and the deals that
were premised on continued high rates of appreciation will go sour. Homeowners who can service
their debt will cling to their optimism and refuse to sell into a softening market. This tenacity
will help keep homes prices from a severe adjustment, but it will make high sales rates of existing
homes a thing of the past.
But without the dot-com mania or the housing bubble to power the economy forward, things will slow
down considerably in 2006. It could become really ugly really fast in the housing sector if there
is a recession with sever job loss, since loss of a job is often enough to force delinquency and
default. History suggests this is likely, but history is not a perfect guide.
The problem sector in terms of job loss is manufacturing, which alone accounts for 60 percent of
job losses. President Bush's biggest problem in his first term was WMD: the Wicked Manufacturing
Decline that occurred during and after the recession of 2001. But sometimes bad things turn out
OK. Though there has been no noticeable pickup in jobs in manufacturing, it is also true there
just aren't that many more jobs to lose.
Thus the good news: The softening of the economy because of problems in housing cannot be amplified
in the way that it had been historically with major job losses in manufacturing. Without that
amplification, we cannot have enough job loss to have a recession.
In other words, rather than a sharp correction, 2006 begins an adjustment that is little-by-little,
lasting several years instead of just one. There won't be as much cocktail chatter about how much
we are making on our homes, but like the frog in hot water, we otherwise will notice - provided
that foreign lenders who have been financing a $700 billion gap between U.S. earnings and U.S.
spending do not start to worry about the U.S. economy and begin to look elsewhere. That could be
where the next recession gets started, though we have never had one in the U.S. that has its roots
in an external deficit.
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