A 3.8 per cent annualized decline in US GDP in the fourth quarter of 2008 is just the first validation of what is likely to be a series of sharp output declines reported in the major industrial economies. Moreover, to the extent that the decline in US GDP was tempered by an unintended pile-up of business inventories, there is good reason to look for further sharp cutbacks in production in the current quarter. Elsewhere around the developed world, the results are likely to be comparable—unusually steep declines in both the fourth quarter of 2008 and the first quarter of 2009.
Be wary of the extrapolation disease, however. As the severe recession call is now validated by actual and prospective trends on the real side of the global economy, many forecasters are now presuming that these unusually steep declines are a portent of the carnage that will endure for quite some time. My dear friend Martin Wolf’s proto-depression scenario is predicated largely on such a presumption.
Far be it for me to make the bull case on this tough global business cycle. In fact, I am just as bearish as I have ever been—especially with respect to my call for a Japanese-like multi-year shakeout for the United States. At the same time, I don’t think it makes good sense to view steep declines as the norm in this recession. My reasoning has to do with the American consumer—the heart of the post-bubble collapse in the US economy. In real terms, personal consumption has just recorded the sharpest back-to-back quarters of contraction in the modern post-World War II era—a 3.8 per cent decline in the third quarter of 2008 followed by a 3.5 per cent drop in the fourth quarter. In the past 60 or more years, there have been only four other instances of back-to-back quarterly declines in US consumption. In none of those instances, did both drops have “3- handles.”
Yes, American consumers still remain highly vulnerable to further weakness. They are saving short, overly indebted, and battered by twin wealth shocks to property and equity investments. And they are getting squeezed on the income side by mounting job losses and further compression in real wages. But experience tells us that US consumption habits are “sticky” as a powerful lifestyle defense motive imparts a certain inertia to spending habits. Once Americans have experienced the joy of watching television on a big-screen plasma set, they don’t go back to a black and white box!
Yes, there is a good deal more to come in the US consumption adjustment. The consumer spending share of real US GDP has only come down only one percentage point to 71 per cent from its record high of 72 per cent hit in early 2007. Mean reversion back to pre-bubble norms suggests a further drop to around 67 per cent. On that basis, only 20 per cent of the multi-year adjustment has occurred. But the stickiness of lifestyle adjustments suggest that subsequent consumption declines should be more modest than those which occurred in the final two quarters of 2008. If that’s correct, the severity of the US recession could also be tempered for a while as well. And if production is lifted to bring de-stocking to an end—a normal development in any recession—I wouldn’t even rule out a positive sequential growth comparison at some point in the second half of this year.
In short, the US business cycle is now being dominated by the post-bubble adjustments of the American consumer that I have long thought would come into play. For that reason alone, I would not extrapolate the severity of the recent declines in US GDP into the foreseeable future. This recession is likely to be known for its duration rather than its depth. Yes, it feels like a firestorm right now. But there should be more ebb and flow in the quarters—and years—ahead. Just ask Japan.
Stephen Roach is chairman of Morgan Stanley Asia and former chief economist at the bank