As of this week, the American economy has been growing for 121 months, the longest since records began in 1854. On the back of it, the global economy – including New Zealand’s – has been sailing through calm waters.
But for how long can the US keep the world from economic doomsday?
Not much longer, according to a recent survey from the US National Association of Business Economics. A majority of its members agree a recession is possible as early as next year.
On betting house sites, markets are waging one in three odds that the next US downturn will happen before the 2020 presidential elections.
This is not to say Armageddon is around the corner. After all, economists in general do not have a good track record of forecasting when the next economic crisis will befall. Either by total blindside – the International Monetary Fund, for instance, has failed to forecast in a timely manner every developed economy recession in the past 30 years. Or by exaggerating the chances of a downturn – having “correctly predicted nine of the last five American recessions,” as the old gag goes.
A more useful exercise is to understand the unusual state of affairs underpinning the current economic expansion and what can potentially go wrong.
The long story short is the US economy is in better shape than one would assume, and worse than one would have hoped.
That means New Zealand should hope for the best while preparing for the worst.
There is something extraordinary in the continuing US prosperity. The economy appears to be navigating in an upside-down world where long-held economic beliefs are constantly being challenged.
Economic booms used to be coupled with rising inflationary pressures, prompting higher interest rates and eventually causing bubbles to burst. Not any more – or at least not yet.
In the past 10 years, low-but-steady economic growth has not been met with higher inflation. If anything, inflation measures have been consistently below the Federal Reserve’s 2% target.
Somehow, expected inflation triggers – ultra-low interest rates, unprecedented large-scale central bank asset purchases (aka quantitative easing), a bullish stock market and the lowest unemployment rates in more than half a century – have been shooting blanks since the last recession.
Further, despite years of reduced lending rates and strong job creation, the value of the US housing stock in terms of national production is still a quarter lower than the 2008 peak, dismissing fears of another housing bubble in the horizon.
Attempting to explain the unexplainable, experts say this time may be different. The economy is more than ever reliant on services, which are less prone to bursts than the manufacturing sector; global supply chains have put another lid on cost pressures; and recently, globalisation and technology (for example, the app economy) have kept wage growth and general prices under check.
Then there is the shale revolution, kickstarting precisely as the economy recovered from the global financial crisis (or the Great Recession, as it is known in the US). It kept energy prices at bay while providing extra stimulus to the economy. Since 2009, US oil production has more than doubled, with the US poised to overtake Russia and catch up with Saudi Arabia as the world’s largest oil exporter by 2024.
Buoyant job markets, tamed inflation and well-behaved asset prices might give the impression that the era of the Great Moderation is here to stay. But beneath the calm waters, there are plenty of reasons to start worrying about the next Big One.
The perfect storm
As The Economist puts it, “this expansion’s remarkable longevity does not mean it will die of old age.” So better brace yourself for stormy weather ahead.
There is growing concern among market watchers that President Donald Trump’s unresolved tariff disputes with China might escalate, disrupting international supply chains and risking global growth. So far, both countries have imposed more than $350 billion worth of tariffs between them, and disputes around Huawei’s participation in new 5G networks show how deep trade wars can go. Tellingly, global trade has been at its slowest pace since 2012.
Another source of worry is the shaky US-Iran relationship. Tensions are running high lately as Iran becomes more assertive, leading to uranium enrichment breaches and skirmishes in the Strait of Hormuz. An open conflict cannot be ruled out, which would abruptly disrupt oil supply markets and regional stability.
Domestically, one-trillion-dollar annual deficits and public debt ceiling disputes are a real sign that America’s fiscal position is not sustainable, with an entitlement crisis looming as baby boomers start to retire in droves and a bipartisan compromise is out of reach.
Moreover, prolonged ultra-low interest rates would have distorted business investment decisions and inflated asset prices, the extent of which we will probably only know once the worst happens. As Warren Buffet jested, “only when the tide goes out do you discover who has been swimming naked.”
Then there are the unknown unknowns: Extraordinary expansions might unleash extraordinary risks that only time will reveal.
Don’t rock my boat
After a decade of steady expansion, the risk of an economic upset should not be negligible.
In fact, there are a few worrying signs already out there: the US Treasury’s inverted yield curves (a well-known harbinger of recessions) have erupted for the first time since 2007; historically high price-to-earnings ratios in the past two years mean stocks might be overvalued and a correction looms; business confidence is falling worldwide for the first time in three years; and sustained deflationary forces are appearing across the Atlantic and the Pacific, with tepid growth in Europe and Japan. The list goes on.
Worryingly, if worst comes to worst, the US government will face additional challenges to fight a new recession. If the current economic environment is uncertain, the tools to deal with an eventual downturn are even more so. Both monetary and fiscal arsenals are undermined by already ultra-low interest rates and bloated central bank balance sheets, as well as high budget deficits and public debt.
Signs are pointing to the calm before the storm. It would be wise for a small and open economy such as New Zealand to start implementing the right policies to lift our productivity and steward our fiscal buffers for the rainy days ahead.
Otherwise, trusting the US is only thing we would have left.
Dr Patrick Carvalho is a research fellow at The New Zealand Initiative.