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Looming Signs of a Global Recession
By Anirvan Banerji
Special to TheStreet.com
Originally posted at 1:06 PM ET 6/29/01 on RealMoney.com
As I noted last month, the key indicators that officially define a recession are
now declining in a way seen only during recessions. Logically, then, there are
just two possibilities. Either the U.S. is already in a recession -- or this is the
worst nonrecession ever.
Recession kills inflation. And yet there are those who still worry about
inflation. Many of them believe, despite clear recessionary signs, that a
recession has been averted, and that we'll soon see a recovery that will
tighten labor markets and raise inflationary pressures. They are just wrong.
Many economists believe that, at least in theory, when the jobless rate stays
below the "non-accelerating inflation rate of unemployment" (NAIRU for short),
inflation rises. Last fall, as the jobless rate sank to a 30-year low of 3.9%, well
below most estimates of the NAIRU, inflation was widely considered a greater
risk than recession -- and that's what the Fed reaffirmed after its November
meeting.
Just seven weeks later, the Fed began one of the most aggressive series of
interest-rate cuts in its history. As economic weakness continued, so did the
rate cuts, demonstrating the severe limitations of the NAIRU as a practical
policy tool.
The Falling FIG
With the markets finally buoyed in the spring by lower short-term rates and
hopes of a quick recovery, the NAIRU perspective fanned worries that with a
recession averted, the expected recovery would soon depress the jobless rate
and revive inflation pressures.
Yet the "future inflation gauge," or FIG, which, unlike the NAIRU, has an
impressive record of anticipating directional changes in the fed funds rate,
continues to plunge, just as it did last fall. In other words, a rise in the funds
rate is nowhere on the horizon. The recent rise in inflation was, in fact,
accurately foreseen by the FIG when it rose to an 11-year high last spring.
And this is the point: Since then, it has plunged, and there are no signs of a
bottom.
Federal Funds Rate (%) and U.S. Future Inflation Gauge
(1992=100)
Source: Economic Cycle Research Institute
What does the FIG know that NAIRU doesn't? Well, for one thing, the NAIRU
idea is simple -- too simple for a complex economy -- whereas the FIG is
designed to be a broad measure of underlying inflation pressures. In
particular, the NAIRU does not take into account the fact that the U.S.
economy is significantly influenced by the global economy.
That is why, in the late 1990s, when U.S. growth was robust and the jobless
rate was falling, inflation remained subdued. Some puzzled economists talked
of a new paradigm, while others lowered their estimates of the NAIRU.
In reality, with several Asian economies, including Japan, in recession, there
was a global glut, which sent U.S. import prices falling for four straight years,
from 1995 to 1999. Thus, imported deflationary pressures neutralized
domestic inflationary pressures, allowing a period of noninflationary growth.
When in 1999 the Japanese economy began to expand, resulting in the first
synchronous global expansion in years, the global glut was quickly soaked up
and U.S. import prices started to rise. The Fed, along with other central
banks worldwide, started raising interest rates, ignoring the new paradigm.
The tide has now turned. There is now not only a U.S. recession, but a global
industrial downturn, and U.S. import prices are plunging again.
A Global Recession?
Today, recession has hit not only the U.S., but also the world's
second-largest economy, Japan. The new Koizumi government is planning
reforms that, however well-intentioned, will drive the economy deeper into
recession in the near term. And with interest rates at zero, the Bank of
Japan can hardly ease rates much further.
The problem is that the world's third-largest economy, Germany, may also be
headed toward a recession. German Economics Minister Werner Muller
warned last week that the German economy could see zero growth in the
current quarter. You can read between the lines.
In fact, shortly after Muller's statement came a sharp drop in the widely
followed German Ifo business confidence index, prompting many analysts to
predict negative GDP growth this quarter, along with a slide into recession.
The expectations component of the index fell to its lowest reading since 1993,
when the last German recession was in progress.
Actually, this should have been no surprise. Growth in ECRI's German Long
Leading Index (GLLI) plunged not long ago to its lowest reading since the
last recession. The ECRI gauge anticipates cyclical turns in the expectations
index quite consistently, as shown in the chart, and there is no sign of any
revival in the GLLI.
German Long Leading Index and Ifo Expectations Index
Source: Economic Cycle Research Institute
When I showed the above chart at an European conference last October,
economists were incredulous. The chief economist of a large German
automaker assured me that the best German economists all agreed that there
was no slowdown ahead. In fact, 2001 was going to be the year that German
growth finally surpassed U.S. growth. That goal may remain a dream for a bit
longer.
If Germany goes into recession, which now appears to be a serious
possibility, it would be the first time since the first oil shock a quarter of a
century ago that the world's three largest economies would be in synchronous
recessions. And you can be sure that their neighbors would not remain
unaffected.
Already, with Mexico seeing two straight quarters of negative GDP growth,
President Vicente Fox has acknowledged that the economy is in recession.
Canada's monthly GDP was flat from December 2000 to March 2001, the
latest reading. Across the Pacific, Taiwan, Korea and Australia have all seen
one down quarter of GDP.
A recession in Germany, which accounts for a third of eurozone GDP, would
have serious, Europe-wide ramifications. Yet the European Central Bank,
mandated to conduct a one-size-fits-all monetary policy, has so far been able
to cut rates only by a symbolic quarter-point. Clearly, even with a global
recession looming, it is pretty much up to the Fed to try and revive global
growth single-handedly.
So why did the Fed cut rates by just a quarter-point this week? The reason is
actually pretty clear.
Had it cut rates by half a point, the NAIRUvians in the bond market would
have started worrying about the Fed ramping up inflation pressures and
boosted long rates, which would slow the economy further. This would have
been pretty counterproductive from the Fed's standpoint.
In any event, interest-rates cuts act with almost a year's lag, so the size of
the latest cut is not the point. The immediate issue -- economic recession --
is still the same. Thus, the Fed will keep moving rates down until there are
actual signs of recovery in the leading indicators.
The reality is that we may be facing the second global recession in the
postwar era. Thus in a global economy, it should be patently obvious that
inflation is a nonissue -- except to the bond ghouls trapped in the NAIRU
straitjacket.
Anirvan Banerji is the director of research for the Economic Cycle Research
Institute, which was founded by Dr. Geoffrey H. Moore, creator of the original
index of leading economic indicators (LEI) for the U.S. Department of
Commerce. Banerji is on the economic advisory panel for New York City, and
is also a member of the OECD Expert Group on Leading Indicators. At time
of publication, neither Banerji nor his firm held positions in any securities
mentioned in this column, although holdings can change at any time. Under
no circumstances does the information in this column represent a
recommendation to buy or sell stocks. While Banerji cannot provide
investment advice or recommendations, he welcomes your feedback at
Anirvan Banerji.
KJC |
