Are dollar woes likely to continue?
The term ‘recession’ is a lot in vogue these days and we have all heard of a similar term called ‘depression’. In the context of economics, both sound similar, but there is a difference between the two. A joke amongst the classic economists has termed a recession as when your neighbor loses his job and a depression when you lose your job.
The macroeconomics definition of ‘recession’ is a negative growth in a nation’s real GDP for two or more consecutive quarters. Just what the hell is real GDP. As it is there are so many confusing terms as GDP, GNP, National Income etc. and now a new addition ‘real’.
‘Real’ is a term that is very important, especially in a recessionary context. Real growth in GDP refers to the increase in the gross domestic product adjusted to inflation. You could imagine a situation, where the GDP grows by 5% in nominal terms, but is accompanied by an inflationary rate of 6%. The real growth in GDP is actually -1% after adjusting it to the price rise. But what is a depression? A depression is a severe form of recession, where the decline in the real GDP is as high as 10% or the recession stretches over a prolonged period.
A recession is usually accompanied by a fall in employment and investment in the economy leading to businesses closing shop and a decline in profits.
History of recessions in the US
The 1929, the Stock Market Crash, and the ensuing depression of the 1930s was termed as the Great Depression. Real GDP fell 33% between August of 1929 and March of 1933. This was followed by a period of recovery, and another milder depression of 1937-38, which is also considered the last depression in the economic history of the US.
The oil crisis of the 70s, which was triggered by an increase in oil prices by OPEC, led to a period of stagflation in the US. The period was marked by a high inflation rate of 12%, and an unemployment rate of nearly 9%. High inflation led to higher interest rates and the US economy was mired in recession, which lasted nearly 16 months between 1973 and 1975.
The US was struck by a recession again in the 1980s coinciding with the commencement of Ronald Reagan’s presidency. The US Fed at that time took the harsh measure of jacking up interest rates to 20% to beat inflation. But it appears that along with inflation, the Fed chairman, Paul Volker managed to lead to the closure of a large amount of industry bearing the brunt of high interest rates. Unemployment increased and the economy sagged leading to a lot of hardship to the American people.
The late 80s were marked by the savings and loan crisis in the US, which led to a property market crash. Several banks went out of business and a recession followed in 1990-1992. The ensuing liquidity crunch made it hard for industry to get loans, making the recession even stickier. The Fed lowered interest rates nearly 23 times, but recovery was very sluggish. The makings of this crisis are similar to the current sub-prime led debacle, making the possibility of a recession more real.
It may be noted that the US has been through nearly 30 cycles of economic expansion and contractions since the mid 19th century. The average period for expansion and contraction has been 17 months and 38 months respectively. The good news is that the intensity of the recessions has been decreasing over the successive recessions, which may be attributed to a successful handling of the crises by the Fed.
Current status of the US economy
Given the fact that a recession is marked by a contracting real GDP, increasing unemployment, reduced investment activity and reducing consumer sales, we need to evaluate if the US is entering a recessionary phase.
The latest job loss results released by the Labor Department earlier this month suggested that US employers have slashed 80,000 jobs in March. This has led to the unemployment rate jumping to 5.1%. The job cuts in the months of January and February were similar in nature indicating the depth of the problem. The housing slump reportedly led to job losses to the tune of 51,000 workers recently, leading to a total reduction of jobs in the sector to over 350,000 in the last one year.
A key factor pointing towards the onset of recessionary tendencies is the admittance by the chairman of the Fed that a recession may be possible this year. The rapid moves by the Fed to cut interest rates and the rescue of Bear Sterns also point towards the growing concern of the Fed about recession.
We all know that the key trigger to the current recessionary phase in the US was the sub-prime lending in the property segment. The S&P Case Schiller index suggests that home prices have dwindled 13% on average from their peak values. The decline in property value has reportedly left a nearly 10 million people owing banks more than the value of their homes. The excess supply of homes and dampened demand is likely to lead to further reduction in property prices. The chart on the left clearly indicates diminishing sales and an increasing inventory.
At the same time, we are all aware of oil prices which have crossed the $100 mark. Increased oil prices, and its inflationary impact is likely to increase costs of other consumables. Falling house prices, a liquidity squeeze, falling employment levels and increasing consumer prices are likely to put the Americans in a bind and force them to reduce consumer speeding. Consumer spending is the key driver to the US economy. Nearly 70% of the US economy is consumption driven. Thus, all factors seem to point towards the fact that the US may be headed for a recession.
The key question now is that how long is this recession likely to last? As discussed earlier in the article, the bust cycles in the US economy have tended to become shorter and shorter. This has been a result of the Fed having successfully used various tools in its armory to fight recession and to keep boom cycles at a moderate level. The weaker dollar has also led to some boost in exports, with demand from other parts of the ward still sustaining itself. A boost in exports has provided some cushioning to the falling industrial activity. Thus, while the US seems to be headed towards a recession, it may not be that long lasting. Economists are of the opinion that recovery may begin towards the end of 2008, especially in the context of the Fed taking bold steps.
Impact on the dollar
While the dollar may have factored in a lot of this news and its value may already be reflective of the weakened economy, the currency is likely to display weakness and may be unable to appreciate in the near short term. Any strengthening of the currency is likely to depend upon how the economy fares and revives itself.