Kash’s Call #2: The Economic Recovery

My second prediction: the recovery will continue apace for another few months… but will start to die out by summer 2004.

Why? Put simply, I think that the bulk of the economic growth that we’re experiencing right now is due to the credit card binge that AB so aptly described yesterday. And that credit card binge will be coming to an end soon, without any source of economic growth to replace it.

We can divide the economy into four pieces, and consider each in turn.

1. Government taxing and spending (G and T, for those of you who’ve taken a course in macroeconomics): We haven’t quite maxed out on our national credit cards yet, but we’ve probably reached the peak of the current round of expansionary fiscal policy. Bush says he now wants to seriously rein in spending (though we’ll see about that). For sure, the tax cuts have largely come and gone by now. If the budget deficit starts to shrink mid-way through 2004 as it’s projected to, that implies a fiscal drag on the US economy. So G and T will start slowing the economy after the summer of 2004.

2. Consumer spending (C): Consumer spending has been rising like gangbusters (relative to everything else) over the past couple of years. But consumer debt is now at record levels (even if you look at payments/income instead of the gross level of debt), credit card defaults are at record levels, people have mortgaged their houses up to the hilt and already spent the proceeds, and the tax rebates and cuts will have been largely spent by May. That leaves one source for possible increased consumer spending: current income. But since my prediction is for a slowdown in the economy this summer, that implies a slowdown in consumer spending, too. So C doesn’t help the economy, and probably starts hurting it later this year.

3. Business spending (I): Yes, there’s a bit of pent-up demand for business spending to replace old equipment, but not much. The things that worry me hear are 1) corporate debt, which is still historically very high (though not quite as high as in 2001); and 2) excess capacity. Firms are wallowing in tons of excess capacity. Until that starts to get used up, businesses will not undertake further major expansions. So I will not provide a sustainable source of economic growth in the next year.

4. Foreign trade (X and M): Here we have the one real possibility for help. Thanks to the falling dollar, we may see some pick-up in exports. However, I don’t expect it to be a big one, for a couple of reasons. 1) It takes a long time for a fall in the dollar to translate into a major change in trade – like 2 or 3 years; 2) US exports depend not only on prices, but also on how much income the rest of the world has. With pretty sluggish economic growth around the world, there’s a big question mark about that; 3) Fundamentally, the US is not going to have an improving trade balance until it starts saving more and spending less as a country. In the absence of the latter, the fall in the dollar will just be offset by an increase in export prices and a fall in import prices, keeping US trade about where it is now. So X and M will not provide a big stimulus to the US economy this year.

Add it all together, and what do you get? Continued growth for a few more months, perhaps, but tapering off in the second half of the year.