Aug062014

Will a global economic slowdown trigger a US recession and housing bust?

A global economic slowdown could trigger a US recession and potentially cause another housing bust.

The US economy struggles for growth five years after the Great Recession officially ended. Economists point to encouraging signs of future growth — just as they erroneously have over the last five years. The green shoots meme is so old and overused that economists tire of using it, reporters tire of reporting it, and ordinary citizens tire of hearing it. Realistically, the US economy is still fragile, and a global economic slowdown could easily trigger a recession in the US, but would that recession cause another housing bust?

Economist who predicted busted housing bubble says another recession is coming

By Bernard Condon, Associated Press, Posted: 07/22/20144.2.7

… sluggish growth in France, Italy, Russia, Brazil and China suggests that the old truism, “When the U.S. sneezes, the rest of the world catches a cold,” may need to be flipped.Maybe the rest of the world will sneeze this time, and the U.S. will get sick.

That’s the view of David Levy, who oversees the Levy Forecast, a newsletter analyzing the economy that his family started in 1949 and one with an enviable record. Nearly a decade ago, the now-59-year-old economist warned that U.S. housing was a bubble set to burst, and that the damage would push the country into a recession so severe the Federal Reserve would have no choice but to slash short-term borrowing rates to their lowest levels ever to stimulate the economy. That’s exactly what happened. Now, Levy says the United States is likely to fall into a recession next year triggered by downturns in other countries, the first time in modern history.

The recession for the rest of the world … will be worse than the last one,” says Levy, …

Worrisome signs are already out there. Unlike their U.S. counterparts, European banks are still stuck with too many bad loans from the financial crisis. Household and business debt there is too high. And confidence is fleeting, as investors saw earlier this month when stocks sold off on worries over the stability of Portugal’s largest bank.

no_double_dipIn the past recessions were a crucible burning off bad debts, repricing assets, eliminating Ponzi schemes, and preparing economies for efficient economic growth. For as severe as the Great Recession was, it did none of those things because to preserve the solvency of our banking system, the bad debts were allowed to persist, rates were lowered to sustain Ponzi schemes, asset values were reflated to prevent true price discovery, and as a result, we experienced five years of tepid economic growth, and we stand perched on the edge of another recession — all because we didn’t do what was necessary five years ago and purge the bad debt from the system. Every major economic power in the world has done the same thing, so now the entire world economy is overburdened with debt, central banks are printing money like mad to stave off deflation, and fears of the Great Reset abound.

In China and other emerging markets, the old problem of relying on indebted Americans to buy more of their goods each year and not selling enough to their own people means a glut of underused factories.

The world hopes to ride on the coattails of the U.S. consumer,” says Eswar Prasad, an economist at Cornell University, “but the U.S. consumer isn’t in a position to take on the burden.”

The whole world is relying on the US consumer who isn’t making any more money and has too much debt already, even at near record low rates. Somebody, somewhere needs to start buying US products to lift us out of recession so the US consumer can earn enough to pay off the old debts — those debts that weren’t purged from the system — and make enough money to buy new products from emerging economies. If a global slowdown hurts US exports, the virtuous circle of economic growth will never get off the ground.group_failure

Emerging markets bounced back faster from the financial crisis than did rich countries, but Levy thinks a big reason for that has made things worse. Overseas companies plowed money into factories, machines and buildings used to make things on the assumption that exports, after snapping back from recession lows, would continue to grow at their prior pace. They have not, a big problem since companies had been investing too much to expand production before the crisis, too.

Compared to such fragile economies, Levy says the U.S. is in decent shape. Like most economists, he’s not worried about the nation’s 2.9 percent drop in economic output in the first quarter, attributing it to harsh winter weather. He expects growth to return, but not for long, as a recession in either Europe or emerging markets spreads to the U.S.

Levy says the U.S. is more vulnerable to troubles abroad than people realize. Exports contributed 14 percent of U.S. economic output last year, up from 9 percent in 2002. That sounds like a good development, but it also makes the country more dependent on global growth, which, in turn, relies more on emerging markets. Those markets accounted for 50 percent of global output last year, up from 38 percent in 2002.

The traditional model for growth out of a recession, also known as beggar thy neighbor, is to devalue the currency making domestic goods and services less expensive abroad, stimulating exports, increasing employment, and circulating more money through the domestic economy. Unfortunately, when everyone’s economy turns south, as they did in 2008, every country in the world can’t implement a beggar thy neighbor policy at the same time effectively. With the entire world economy running on printed money from a variety of central banks, everyone gets nowhere.

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Levy predicts a U.S. recession will throw its housing recovery in reverse, and push home prices below the low in the last recession.

Why would a recession push home prices below the low in the last recession? In fact, I don’t see how a recession will push home prices lower at all. Even if unemployment surged again, lenders would modify everyone’s loans to avoid foreclosure, and the amend-extend-pretend dance would go on for another session. We can be fairly certain that the US banks will not foreclose and cause another price crash by putting must-sell inventory on the market, even if that means there are no sales at all. Realistically, and this is a concern, the collapse of the Chinese real estate bubble could turn today’s Chinese buyers into tomorrow’s desperate sellers. That would put must-sell inventory on the market and cause prices to go down.delay

He says panicked investors are likely to dump stocks and flood into U.S. Treasurys, a haven in troubled times, like never before. The yield on the 10-year Treasury note, which moves opposite to its price, is likely to fall from 2.5 percent to less than 1 percent — an unprecedented low. In 2012, when investors feared a breakup of the euro-currency bloc, the 10-year yield fell to 1.4 percent. …

IMO, this is where this man’s analysis falls apart. Let’s say his scenario plays out as described; wouldn’t that push mortgage rates down to about 3%? And wouldn’t 3% mortgage rates support house prices even if incomes dropped? The answer to both questions is yes, so the global slowdown he worries about may hinder sales volumes as fewer and fewer people have qualifying income to buy houses, but those that do still have jobs will have extraordinary buying power. When combined with restricted inventory from the inevitable loan modifications, a global slowdown resulting in 3% mortgage rates would probably push house prices higher.

We have reason to be concerned about a global slowdown. Another recession won’t make anyone feel better, particularly those who’ve been unemployed since the last one; however, a global slowdown won’t cause a housing crash. For bears looking for a reason to avoid housing, the deflating Chinese housing bubble is far more worrisome.

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