Nouriel Roubini's Global EconoMonitor

American Pie in the Sky

From Project Syndicate:

While the risk of a disorderly crisis in the eurozone is well recognized, a more sanguine view of the United States has prevailed. For the last three years, the consensus has been that the US economy was on the verge of a robust and self-sustaining recovery that would restore above-potential growth. That turned out to be wrong, as a painful process of balance-sheet deleveraging – reflecting excessive private-sector debt, and then its carryover to the public sector – implies that the recovery will remain, at best, below-trend for many years to come.


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Even this year, the consensus got it wrong, expecting a recovery to above-trend annual GDP growth – faster than 3%. But the first-half growth rate looks set to come in closer to 1.5% at best, even below 2011’s dismal 1.7%. And now, after getting the first half of 2012 wrong, many are repeating the fairy tale that a combination of lower oil prices, rising auto sales, recovering house prices, and a resurgence of US manufacturing will boost growth in the second half of the year and fuel above-potential growth by 2013.

The reality is the opposite: for several reasons, growth will slow further in the second half of 2012 and be even lower in 2013 – close to stall speed. First, growth in the second quarter has decelerated from a mediocre 1.8% in January-March, as job creation – averaging 70,000 a month – fell sharply.

Second, expectations of the “fiscal cliff” – automatic tax increases and spending cuts set for the end of this year – will keep spending and growth lower through the second half of 2012. So will uncertainty about who will be President in 2013; about tax rates and spending levels; about the threat of another government shutdown over the debt ceiling; and about the risk of another sovereign rating downgrade should political gridlock continue to block a plan for medium-term fiscal consolidation. In such conditions, most firms and consumers will be cautious about spending – an option value of waiting – thus further weakening the economy.

Third, the fiscal cliff would amount to a 4.5%-of-GDP drag on growth in 2013 if all tax cuts and transfer payments were allowed to expire and draconian spending cuts were triggered. Of course, the drag will be much smaller, as tax increases and spending cuts will be much milder. But, even if the fiscal cliff turns out to be a mild growth bump – a mere 0.5% of GDP – and annual growth at the end of the year is just 1.5%, as seems likely, the fiscal drag will suffice to slow the economy to stall speed: a growth rate of barely 1%.

Fourth, private consumption growth in the last few quarters does not reflect growth in real wages (which are actually falling). Rather, growth in disposable income (and thus in consumption) has been sustained since last year by another $1.4 trillion in tax cuts and extended transfer payments, implying another $1.4 trillion of public debt. Unlike the eurozone and the United Kingdom, where a double-dip recession is already under way, owing to front-loaded fiscal austerity, the US has prevented some household deleveraging through even more public-sector releveraging – that is, by stealing some growth from the future.

In 2013, as transfer payments are phased out, however gradually, and as some tax cuts are allowed to expire, disposable income growth and consumption growth will slow. The US will then face not only the direct effects of a fiscal drag, but also its indirect effect on private spending.

Fifth, four external forces will further impede US growth: a worsening eurozone crisis; an increasingly hard landing for China; a generalized slowdown of emerging-market economies, owing to cyclical factors (weak advanced-country growth) and structural causes (a state-capitalist model that reduces potential growth); and the risk of higher oil prices in 2013 as negotiations and sanctions fail to convince Iran to abandon its nuclear program.

Policy responses will have very limited effect in stemming the US economy’s deceleration toward stall speed: even with only a mild fiscal drag on growth, the US dollar is likely to strengthen as the eurozone crisis weakens the euro and as global risk aversion returns. The US Federal Reserve will carry out more quantitative easing this year, but it will be ineffective: long-term interest rates are already very low, and lowering them further would not boost spending. Indeed, the credit channel is frozen and velocity has collapsed, with banks hoarding increases in base money in the form of excess reserves. Moreover, the dollar is unlikely to weaken as other countries also carry out quantitative easing.

Similarly, the gravity of weaker growth will most likely overcome the levitational effect on equity prices from more quantitative easing, particularly given that equity valuations today are not as depressed as they were in 2009 or 2010. Indeed, growth in earnings and profits is now running out of steam, as the effect of weak demand on top-line revenues takes a toll on bottom-line margins and profitability.

A significant equity-price correction could, in fact, be the force that in 2013 tips the US economy into outright contraction. And if the US (still the world’s largest economy) starts to sneeze again, the rest of the world – its immunity already weakened by Europe’s malaise and emerging countries’ slowdown – will catch pneumonia.

23 Responses to “American Pie in the Sky”

ThomasGrennesJuly 20th, 2012 at 3:27 pm

I would add three points that reinforce the gloomy assessment of Nouriel Roubini. The de-leveraging that has slowed the recovery should not be a surprise. Extensive empirical work by Carmen Reinhart along with Kenneth Rogoff and Vincent Reinhart indicates that when financial crises are combined with recessions, the adverse effects can persist for years. Secondly, the short-term recession and recovery problem coincides with the long-term sovereign debt problem that is magnified by demographic developments in the United States that have been ignored by the government. Thirdly, the inability of the Congress and the President to reach agreement on fundamental policies has led to unprecedented levels of economic uncertainty, as measured by Nicholas Bloom and others. Greater uncertainty about future policies can discourage current investment.

WilliamJuly 21st, 2012 at 11:18 pm

As D M said, "there isn't one". We will all need to prepare for a way of life much different than what we enjoy now. We've been living on borrowed money and borrowed time and once contraction comes, watch out!

headlocalJuly 22nd, 2012 at 9:01 pm

William –

best move: figure out who, when, and what to short.


“If you’ve got a business — you didn’t build that. Somebody else made that happen.”


“If you short a business — Somebody else made that happen.”

AnandakosAugust 3rd, 2012 at 4:44 pm

Idiot, Idiot, Idiot,

In the "Roanoke Declaration" as you call it, the "that" referred not to the business but to the infrastructure (highways, schools, etc) itemized in the first clause of the same sentence. A first clause which was oh so artfully (and, typically, dishonestly) omitted by the right wing flacks.

Sierra7July 21st, 2012 at 4:39 pm

Our gov/financial world is not ready for reality….but average citizens face it every day… the above commenter says…."buckle up" for a real long, nasty ride!

benleetJuly 21st, 2012 at 5:41 pm

"Roubini's solutions were published in "The Way Forward", October 2011, at the New America Foundation.
With Alpert and Hockett, Roubini proposed 3 pillars for recovery: 1) a 5 year government jobs program at $240 billion per year or $1.2 trillion total; 2) restructuring of "debt overhang" afflicting banks and homeowners due to the housing bubble. Banks are presently bankrupt as mark-to-market pricing has been suspended. 3) "Pillar 3, global reforms that can begin the process of restoring balance to the world economy and can facilitate the process of debt de-levering in Europe and the United States. Key over the next five to seven years will be growth of domestic demand in China and other emerging market economies" —– I haven't heard Roubini promote this program that he co-authored. Maybe the direct jobs creation portion is regarded as too radical. Unemployment dropped from 25% to 9.6% during 1933-1937 due to direct jobs creation. And the WWII economy increased the total number employed by an incredible 40% due to direct jobs creation. A sort of amnesia has set in regarding this policy. The debt restructuring portion of The Way Forward is intricate and fair, and doable. In 1964 2% of all corporate profits went to the financial corporations, and in 2004 the share was 40%. Meanwhile wage income as a percentage of total personal income has dropped from 53% of GDP in 1970 to 43% range in 2011. We have structural problems. It's as though no one learned anything from the Great Depression era when mortgages were restructured, the finance industry regulated and made innocuous yet functional, and public jobs restored employment, and unions were legalized. My blog:

barfJuly 22nd, 2012 at 4:52 am

really? "when last we checked in with the EZ they were busy about their plans" (with the full support of Wall Street of course) "to replace the dollar with the euro." That was after the collapse of Wall Street…the Big Short…the end of the Iraq War…the coming of Obama. "Something happened on the way to the forum" and explaining that requires a whole lot more than this claptrap. USA Inc is currently in the process of buying Europe. How that happened will go down in history as one of true wonders of the world in my book. I agreed with your original Dr. Doom thesis Professor…but now "the real game begins." Take into account the originality of the the crisis management folks Professor. This has never been about egos. Just "doing the right thing."

crisisJuly 25th, 2012 at 10:39 am

The glibness of these "buckle up" comments is sickening. America is rapidly approaching its highest levels of poverty in 50 years. 47 million Americans – including 22% of all children – live in poverty.

jim pivonkaJuly 31st, 2012 at 5:26 pm

It's not glib at all in my book. It's a rather blunt assessment that the situation you decry will get worse, and that it will affect more and more people, including those now in the middle class and those who consider themselves a part of the "investor class". How you get glib out of that, I do not understand. Perhaps you think there is a way out. There is, or was. But as benleet notes above, that is a road not taken, not apt to be taken, and such a thorough departure from the path we are on that no one is even taking it seriously any more.

FalstaffAugust 2nd, 2012 at 6:03 pm

The U.S. economy is not as bad as the media would have us believe. Certain states and regions of the U.S. are getting better everyday if not booming. One of the problems with living in our democracy is assuming that the lowest common denominator is a fair assessment of everything because it seems to be the most egalitarian. But just like my son's math class that moves a snails pace because of a few kids who just don't get it, sometimes we need to sacrifice part of the herd for the rest to prosper, un-American as it may sound.

PZAugust 11th, 2012 at 10:28 pm

Public debt resembles private debts only superficially. Government goes into debt by issuing its own liabilities that can be used in payment of taxes and are therefore financial assets to the holder. Private debt is debt, but public debt is asset to the private sector.

fornelasAugust 15th, 2012 at 11:17 am

Maybe the whole paradigm of mass production under the increasing technological evolution and globalization is totally unsustainable. On one side of the equation we have the BRICS able to ramp up production any time of the day, i.e. the iphone at FOXCONN. On the other the developed economies cannot sustain their consumption levels , evidences abound in the last 30 years. Therefore all the suggestions on the table are tiptoing on either short run solutions, i.e. fiscal and monetary policy (QE(x)) or huge expensive suggestions intended to encourage further mass production. We are in vicious cycle.

OrigblessAugust 27th, 2012 at 4:56 pm

If our currency is going to be devalued, why not consider Sheila Bair's tongue-in-cheek
thought to give $10,000,000 to all households ($1,000,000 would do) – including renters and tent-dwellers on our city streets. We could all buy utility stocks and have enough income to begin paying off everything and even buying a few new products.
Any other stabilization fantasies out there???

David SpencerNovember 19th, 2012 at 9:20 am

We have two prescriptions on deck. They both taste horrid, and you won't like it, but…

1. The derivatives market needs an additional $3 trillion in Tier 1 capital due to the restrictions of Dodd-Frank. That means Capital Transformation. With bank profit margins imploding, how can they resist? The downside is that all that questionable debt is transferred to the banks' balance sheet. If a downturn takes out whole sectors, the solvency of the banks will be in question.
2. The energy boom in the U.S. will likely be offset at some point by Cap and Trade. With carbon elimination requirements increasing annually, "exceptions" will begin to to take on Tier 1 characteristics. See: 1.