The U.S. is struggling with the worst housing slump since the Second World War. Crumbling home prices and the marked deterioration of hundreds of billions of dollars’ worth of low-quality mortgage debt threatens American consumer spending. The sub-prime meltdown reverberates far beyond the U.S. housing market, though, because it has called into question a decade of financial engineering. The inability of some investors in complex structured debt products to gauge risk has helped lift bank financing costs, constraining credit availability. Some fear the first broad contagion since the one-two blow from the Asian panic and Long Term Capital Management a decade ago. These developments, combined with high energy prices and a further anticipated drop in home-building, set the stage for an economic downshift. We expect U.S. GDP will grow just 2% in 2008, down from its near-5% tempo in the third quarter of 2007.
We do not, however, see an outright recession. Comments by U.S. Federal Reserve chairman Ben Bernanke and others suggest the Fed will further cut interest rates. That should prevent financial markets from seizing up, and keep growth on at least a modestly positive track.
The U.S. dollar’s incredible shrinking act has also reduced America’s trade deficit — thus adding over a percentage point to GDP growth in the most recent quarter. Given still favourable conditions in some of the U.S.’s main trading partners and the dollar’s continuing unpopularity, further trade-deficit reduction should help cushion the blow from the housing slump.
Fortunately, a stumbling U.S. likely won’t push the world economy over the precipice. Global growth should come in just shy of 5% in 2008. That’s below the pace of the past two years, but nearly a percentage point better than the average performance of the last decade. While softer performance stateside will have broader geographic effects, the gravitational pull will be a good deal less than it might have been even a decade ago due to the fast-changing global economic landscape. While it’s true the U.S. led the world out of the 1990s recession, it has accounted for only about 10% of global growth in the past three years, versus 50% for the so-called BRICA nations — Brazil, Russia, India and China, plus the large Middle East oil producers.
Emerging markets have proved much less susceptible to credit market volatility this time around than during earlier shocks, like those of the late 1990s. Emerging market bond spreads have widened by 1% in recent months, just a tenth of the rise seen after the Long Term Capital Management debacle.
No country has contributed more to buoyant global resource demand in recent years than China. Its economy should expand by about 10% in 2008, after an increase of well over 11% in 2007. Taken together, a healthy consumer and massive infrastructure construction, tied in part to preparations for the upcoming Beijing Olympics, suggest the Chinese economy will start 2008 with a good head of steam. Limiting vulnerability to weaker growth stateside, exports to the U.S. account for only about 8% of China’s GDP — and that figure may overstate things. China’s exports typically have a high import content. It’s the foreign suppliers of these components, not Chinese industry itself, that will suffer if export growth cools.
Spearheaded by services and manufacturing, India’s economy has continued to outpace expectations in recent quarters. Even with the drag from recent interest rate hikes, GDP growth should still comfortably exceed 8% in 2008 given the economy’s underlying resilience.
Expectations for the eurozone economy, headed for growth of about 2% in the coming year, have deteriorated slightly in recent months. On a constructive note, however, the European Central Bank appears to have abandoned its earlier plans to tighten further. Higher energy-driven inflation and slower growth taken together appear to signal a holding pattern for monetary policy for the next few quarters. The firmness of the European Commission’s business climate index suggests industrial activity continues to hold up despite the euro’s climb.
Rising oil prices have plunged the world economy into recession twice in the past 30 years, and they aggravated the early 1990s downturn. While those events were essentially supply shocks, the recent run-up in prices is largely due to strong demand, driven by robust economic growth overseas. Despite greater absolute demand, the global economy moreover uses 40% less oil per dollar of GDP than it needed a quarter-century ago, also reducing the threat of another oil-fueled recession.
At the height of the Asian flu a decade ago, half of the world’s economies flirted with recession. Even though risks to the outlook have risen, the current slowdown by comparison still looks like a modest case of the sniffles.
Peter Buchanan is senior economist at CIBC World Markets.
