Double-dip recession floats just beyond the horizon, pundits say

Friday 26th April 2002

The International Monetary Fund has decided to cheer everyone up with revised growth forecasts.

It has picked that fourth-quarter 2001 world economic growth was 1.5% and that the figure for Q4 2002 will hit 4%.

The US is expected to lead the charge, with milder recovery in Europe and contraction in Japan.

If this scenario plays out, we will be pretty much back to where we were with the big three economies before the American slowdown.

A negative in the picture is that the IMF worries that inflation is too low.

We have, of course, become accustomed to the ethos that inflation is a great evil - the less of which the better.

The problem is that disinflation can tip over into deflation, as we have seen in Japan. The Japanese experience gives a counter-example to the thesis that high national savings are necessarily a good thing.

The Japanese must have stuffed every mattress in their country with cash and yet their economy bears marked resemblance to the Titanic after its iceberg encounter.

Clearly a balance must be struck between savings and consumption if an economy is to avoid grinding to a halt. In a deflationary environment, saving burgeons at the expense of consumption.

The Economist has been something of a nay-sayer for quite some time now. It was an early picker of the US sharemarket crash and associated recession.

Predictions yet to be borne out are US deflation in conjunction with a savings-led recession there. If that happens, the US will do a Japan.

But the chances of this are remote, especially given the US' longstanding love affair with living beyond its means.

The question remains open as to whether the country will shop until it drops.

The dreaded DDR phrase - double-dip recession - keeps cropping up in the Economist.

The magazine points out the US' mild recession has been eased by a low-cost credit boom that has increased American household wealth through an associated real estate bubble.

The upturn in economic activity has been consumption driven but much of the impetus has been funded by debt.

US production has not been soaring. The American consumer binge has been soaking up the excess inventory mountain of the largest clearance sale since the end of World War II.

That mountain may yet give birth to a mouse if US firms cannot crank up production again, particularly in a climate of high personal indebtedness.

In New Zealand the same message about debt has come from the Reserve Bank.

On its website is posted a January speech to the Canterbury Employers' Chamber of Commerce.

It summarises governor Don Brash as saying that "most mature and highly developed economies in Europe and North America are either net lenders or have financing from abroad equivalent to only 20-30% of their GDP, whereas New Zealand's net use of foreign capital is nearly 80% of its GDP.

Dr Brash said a high reliance on foreign capital could be justified if it generated exceptional economic growth but in New Zealand that wasn't happening.

His remarks could be modified to apply to the US, which is soaking up two-thirds of the world's cashflow while it produces a quarter of its GDP.

There is no "exceptional economic growth" in the US economy to justify the total indebtedness, which, as Dr Brash criticises New Zealand for, is mainly private sector and principally attributable to households.

As the Economist says in its issue of April 20-26, "Although America's recession has been mild - thanks mainly to interest rate cuts - it has left behind huge imbalances, including a high level of consumer borrowing and a large current-account deficit.

It is likely that these imbalances will cramp the pace of recovery and they may even tip America back into recession."

So there we have it, a potential mechanism for DDR.

Economies hoping to cadge a lift with the US over this year may have another thing coming.

Rallies in sharemarkets have perhaps been premature, especially when there are concerns that US stocks are still overvalued in relation to their earnings potential, and a lift in Federal Reserve interest rates at some stage could produce a triple squeeze on bonds, shares and house prices.

The very medicine of a credit boom could turn to poison in such an environment.

Small wonder then that the Federal Reserve, according to the Economist, is to consider at a conference this week a paper entitled Asset Prices in a Flexible Inflation Targeting Framework by Stephen Cecchetti, Hans Genberg, and Sushil Wadhwani.

These economists argue central banks should lift interest rates to burst sharemarket bubbles when evidence of increased productivity is not forthcoming.

If the Fed takes the advice of the paper, then chairman Alan Greenspan will add asset inflation to the hit-list of monetary policy.

Dr Brash has done that already by belting rising house prices during a previous immigration boom. Retirement savers had better start socking more funds away if the paper's view becomes central bank orthodoxy.

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