Increasingly, prognosticators are talking about a recession in the United States by 2020. But not everyone is onboard with those predictions. Moreover, arguments vary both in terms of why a recession would take hold and in what the likely outcomes are. Below I want to review a few of the predictions, adding some comments of my own.
1 – Ann Pettifor on the increase in private debt
British economist Ann Pettifor believes the beginnings of another financial crisis are already in motion. And given that she predicted the last financial crisis, her comments are interesting. Here’s how Sky News puts it:
Now she thinks the global economy is in danger once more thanks to huge corporate debt, and the prospect of rising interest rates in the United States.
She told Sky News that global debt was now more than three times the level of global GDP.
“So naturally it is not going to be repaid, and naturally there is going to come a point when that debt triggers the next crisis. And, for me, that trigger is going to be high rates of interest,” she said.
“We’re seeing that companies who borrowed too much money at very low rates of interest are now finding the value of their collateral falling. Their debt is rising and the interest on that debt is rising too.”
What’s more, she thinks the process has already started.
She said the US Federal Reserve’s decision to wind back its support for the economy, and reverse its programme of quantitative easing, has already laid the ground for the next crisis.
“In Argentina and Turkey, they are already facing a crisis as a result of the Fed’s decision to diffuse the bomb that is QE, and to increase interest rates,” she said.
“Those decisions have both served to strengthen the dollar, which has hurt their economies.”
She said: “I think it will be worse than the last crisis because we don’t have the tools. It will be really difficult to start pumping out quantitative easing, buying back all those assets.
Why this matters: Ann’s reasoning is perhaps the least controversial of predictions because she puts the blame on burgeoning private debt. Most every macro observer would note that private debt, particularly in the emerging markets, has grown tremendously in the aftermath of the last financial crisis. The question is whether this leads to crisis.
Deeper dive: Ann’s view is that the rate cycle will cause the tide to roll out, with Argentina and Turkey being the first to run aground as a result. She believes that, as the tightening cycle continues, these countries will be joined by corporate debtors in trouble. And eventually this will lead to crisis.
Her view is notable in predicting the next crisis as worst than the last, which would suggest a ‘Great Deptression’ scenario. So this is very alarming, indeed.
Personally, I am willing to entertain the idea that the recession is delayed and that it is less severe than the last because policymakers act with overwhelming force. But my view is closest to hers because it is not predicated on government debt as a trigger and it sees a limit to likely policy responses.
2 – Nouriel Roubini sees recession by 2020 with limited policy choices
I talked about Nouriel on Friday, in part because of a Twitter exchange between him me and MMT economist Stephanie Kelton. The highlighted bit in the next to last paragraph in this post by Nouriel started the exchange:
The current global expansion will likely continue into next year, given that the US is running large fiscal deficits, China is pursuing loose fiscal and credit policies, and Europe remains on a recovery path. But by 2020, the conditions will be ripe for a financial crisis, followed by a global recession.
There are 10 reasons for this. First, the fiscal-stimulus policies that are currently pushing the annual US growth rate above its 2% potential are unsustainable. By 2020, the stimulus will run out, and a modest fiscal drag will pull growth from 3% to slightly below 2%.
Second, because the stimulus was poorly timed…
Meanwhile, inflation is also increasing in other key economies, and rising oil prices are contributing additional inflationary pressures…
Third, the Trump administration’s trade disputes with China, Europe, Mexico, Canada and others will almost certainly escalate, leading to slower growth and higher inflation.
Fourth, other US policies will continue to add stagflationary pressure, prompting the Fed to raise interest rates higher still…
Fifth, growth in the rest of the world will likely slow down…
Sixth, Europe, too, will experience slower growth, owing to monetary-policy tightening and trade frictions…
Seventh, US and global equity markets are frothy…
Moreover, the leverage in many emerging markets and some advanced economies is clearly excessive…
Eighth, once a correction occurs, the risk of illiquidity and fire sales/undershooting will become more severe.
In the case of a risk-off, emerging markets and advanced-economy financial sectors with massive dollar-denominated liabilities will no longer have access to the Fed as a lender of last resort…
Ninth, Trump was already attacking the Fed when the growth rate was recently 4%. Just think about how he will behave in the 2020 election year, when growth likely will have fallen below 1% and job losses emerge…
Finally, once the perfect storm outlined above occurs, the policy tools for addressing it will be sorely lacking. The space for fiscal stimulus is already limited by massive public debt. The possibility for more unconventional monetary policies will be limited by bloated balance sheets and the lack of headroom to cut policy rates. And financial-sector bailouts will be intolerable in countries with resurgent populist movements and near-insolvent governments.
In the US specifically, lawmakers have constrained the ability of the Fed to provide liquidity to non-bank and foreign financial institutions with dollar-denominated liabilities. And in Europe, the rise of populist parties is making it harder to pursue EU-level reforms and create the institutions necessary to combat the next financial crisis and downturn.
Why this matters: The debate on the likely fiscal response is big because it could be the difference between recovery and depression.
For example, I tweeted the post by Nouriel regarding his prediction, which he retweeted. Stephanie noticed that his post implicitly indicated large deficit would limit the fiscal response and balked at this concept, rightly.
Deeper dive: My response was that the term ‘political’ is implied in the lack of fiscal space. But Stephanie wasn’t buying it. She saw Nouriel as on the wrong side of the fiscal space issue. Below is the initial tweet.
We are due a recession in 2020 – and we will lack the tools to fight it via @Nouriel https://t.co/OjDuRtGqZJ
— Edward Harrison (@edwardnh) September 14, 2018
Here was my response to Stephanie’s pushback. Click through for the thread that followed.
When @Nouriel wrtes “The space for fiscal stimulus is already limited by massive public debt,” the word political is implicit i.e. “The [political] space for fiscal stimulus is already limited by massive public debt.” cc @StephanieKelton https://t.co/5e9djMdaBI
— Edward Harrison (@edwardnh) September 14, 2018
As I wrote on Friday though, I’m not concerned about the economics here as much as the outcome. And I think Nouriel’s outcome is plausible, even probable. In fact, in July, I wrote why it’s likely on the fiscal and monetary fronts. Moreover, nothing he says is at odds with what Ann has said.
3 – Jan Hatzius sees no recession by 2020
Here’s what Goldman’s Jan Hatzius is saying:
Recession risk is low, even when looking out over the next three years, according to Goldman Sachs.
The firm said the chance of a U.S. recession is “muted” in the near term, and at 36 percent over the next three years, below the historical average.
“Our model paints a more benign picture in which robust growth—coupled with receding concerns that financial conditions were unsustainably easy—have so far put a lid on US recession risk,” Goldman economists wrote.
They said there has been increasing investor interest in the chance of a recession in the U.S. over the next few years.
For sure, the flattening yield curve, where the shorter-term Treasury yields are rising closer to longer-term yields has created some concern about the economic outlook, as has the Fed tightening cycle. A flattening yield curve can lead to an inverted curve, where the short-end rates are higher than longer term, a reliable recession indicator.
Weakness in emerging markets and China has also created concerns that the U.S. economy could ultimately be impacted.
“Historical experience suggests that recessions in the U.S. have gone hand in hand with recessions elsewhere. Looking at the past four decades, the average chance of a recessionary quarter in the next year in another DM economy is just over 20% if the US is not currently in recession but nearly 70% if it is,” noted the Goldman economists.
The correlation to other developed markets has decreased with each U.S. recession from 1980 to 2001. However, the financial crisis triggered recession in nearly all developed economies, the economists added.
Why this matters: Hatzius is one of the most respected macro economists on Wall Street. And he’s saying the chance of recession is lower than the historical average. That certainly gives me some pause about predicting a recession. And I suspect his model uses the sectoral balances approach that famed late British economist Wynne Godley used to predict an eventual crisis in the eurozone. I see this approach as useful for anticipating medium-term downside risks.
4 – My view
I am on record looking at Turkey as a canary in the coal mine for private debt vulnerability. So I give credence to Ann Pettifor’s view.
At the same time, Nouriel Roubini’s framework for why a recession could happen is credible, though that’s not the macro framing I would use. Importantly, however, Nouriel also talks about a limited policy response, something I am also on record as expecting.
Finally, Hatzius is on the other side of this. And just because he has been such a good prognosticator, I am looking at his view closely. Goldman’s macro model is a black box though. And Goldman strategists Charles Himmelberg and James Weldon are much more concerned, at least regarding risk assets. Bloomberg wrote today:
Rising U.S. interest rates are probably just beginning to roil risk appetite around the world, according to economists at Goldman Sachs Group Inc.
Global investors may be underestimating the headwinds to financial assets posed by U.S. rates, they said. While the real rate on three-month U.S. Treasury bills — or the nominal rate minus inflation (or inflation expectations) — remains negative, Goldman forecasts the measure will diverge from other real rates in the developed and developing world over the next year-and-a-half.
Decent economic data from emerging markets helped mask the rise in real rates earlier this year, but that “changed in April, when a deceleration in EM data arguably exposed the risk consequences of this divergence in policy rates,” strategists Charles Himmelberg and James Weldon wrote in a report dated Sept. 16.
“As the rate of return on safe assets rises, the appeal of risky assets falls, and we increasingly worry that rising trend in U.S. real rates vs. global rates is ‘boiling the frog’ on risk appetite,” they added. “An increase in the fragility of risk appetite is already visible in EM, we would argue, but it logically extends to global risk assets more generally.”
This is where I am. And I believe a downdraft in global risk assets will have a negative effect on credit markets and business investment, leading to defaults and eventually recession.