Dow plunge threatens double dip as US slides further into a recession

By Neville Bennett

Friday 9th August 2002

The US is entering a further recession and a "double dip" in the coming year, New York-based FX Concepts forecasts.

Double-dip refers to the Dow Jones plunging from 8400 to 6000 and the US dollar depreciating about 15% against the euro to $1.10.

The double dip concept has also emerged in the analysis of Stephen Roach, Morgan Stanley's chief economist. He says US growth rates have been revised downward and contends the economy is now at a stall. He warns another shock will "trigger the double dip."

The shock may emerge from corporate collapse, corporate cost cutting, a credit crunch, a downturn in housing or another geopolitical shock.

Mr Roach believes demand always relapses when business in recovering from recession. Double dips "are the rule" in past business cycles and the likelihood of another soon is 60-65%. This will have "actionable implications for stocks, bonds and currencies."

While not actually defining a double dip, Mr Roach implies a fall in both economic growth and in asset prices. FX emphasises stock and currencies. The emphases are different but these asset classes are linked.

When the Dow falls the dollar usually does, too. The Dow contracts on news of faltering growth. The economy is a primary cause of concern. As was discussed somewhat prophetically in The National Business Review (July 19), US GDP figures are often revised. The latest revisions cover three years and have seen growth estimates downgraded for five quarters after the second quarter of 2000.

What had seemed a period of slow growth is now officially a recession over three consecutive quarters. The margin between peak and trough was only 0.6%. Business capital spending fell $US88 billion. This was greater than the loss of GDP, so the recession was obviously offset by the resilience of the housing market (NBR, April 12) and spending on consumer durables such as autos.

It is now clear the tech-wreck wrought much destruction. The collapse of the bubble accounted for 70% of the fall in capital spending and 100% of the fall in GDP. Most commentators picked a growth rate of 3.5% for this quarter but they were too optimistic. The economy is actually near a stall speed of 1.1%.

There are numerous risks. Shocks could emanate from plunging markets, politics, corporate malfeasance and foreign events. More probably, there will be further statistical revisions of the current account deficit. A downward revision will slow capital inflows and put downward pressure on the dollar. Savings data is troublesome. The present rate is 4%, well below the trend of 8.6% for 1950-94. Capital investment is low.

Debt levels are undoubtedly excessive. US household debt is 76% of GDP and business debt is 68% of GDP. These percentages will rise as GDP has been revised downward.

Many agree with President George Bush that the US has been partying. There are excesses in consumption, borrowing and speculating. There is a price to pay and growth cannot resume until the excesses are purged and assets brought to realistic levels.

Wall Street has been derailed by a realisation the economic recovery has faltered. The Nasdaq posted losses in 16 of the past 20 weeks. GDP revisions were confirmed by disappointing employment data.

The diminishing recovery affects business profit expectations although there may be a lift from falling interest rates, which lower costs. Bond yields are trending down and the December futures contract indicates 1.5% overnight interest rates. The market firmly expects US Federal Reserve chairman Alan Greenspan falling by another 25 points.

Falling interest rates are unlikely in themselves to counter other negative pressures. The Institute of Supply Management index of manufacturing sank to 50.55% in July from 56.2% in June. New orders fell sharply from 60.8% to 50.4%; employment fell from 49.75% to 45%. Wall Street plunged on the release of these figures: it was as if an engine had dropped off.

The data suggests the bear market is not over. FX Concepts makes the historically valid point that "bottoms are made when sellers have finished their selling and when buyers are too discouraged to buy anymore." Moreover, while the bottom is forming, people do not "even want to discuss the market." This seems a valid observation of New Zealand after the 1987 crash. The share clubs vanished. The people who got burned have barely returned to the market.

Wall Street will fall further. Falling equities will cause the depreciation of the US dollar. It has been strong in part because of its competitive long-term interest rates. The interest rate curve was steep; with low short rates but high rates for 10 to 30-year bonds.

Investor flight from equities to bonds has forced long-term rates down. The US curve has lost its margin over the euro. Thus, the US is caught in a triple dip of its economy, sharemarkets and currency.

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