Now that the consensus opinion is coming around to the slow growth case for the economy, speculation about a possible “double dip” is gaining currency. Slowing growth does not necessarily project to another recession. Recessions are typically triggered by a shock. However, slow growth – really slow growth – can make an economy particularly vulnerable to a shock. The truth is that the journey to correct the imbalances which led to the Great Recession has been and will probably continue to be marked by periodic shocks.
The US consumer, with the aid of the financial sector, borrowed increasing amounts starting in the early 1980s. The Federal Reserve increased the Fed Funds Rate to a high of 20.5% in 1981 to break the back of the inflation of the 1970s. Over the many years since then, interest rates have been in a long-term downward trend, with periodic interruption, to the point where we are today. Declining interest rates enabled consumers to steadily increase their borrowing capacity until, that is, the housing bubble burst in 2007.
Since 2007, we have had a series of shocks, each of which we have looked at in relative isolation, and each of which we have “solved”. What started as a subprime mortgage problem seemed containable. Then two subprime hedge funds sponsored by Bear Stearns collapsed. We know it did not stop there. The following year, 2008, Bear Stearns was absorbed into J.P.Morgan. Lehman Brothers went bankrupt. Merrill Lynch was forced into an alliance with Bank of America. Goldman Sachs and Morgan Stanley sought protection by becoming banks. The Federal Reserve supported Citibank. Despite the billions of TARP money, many banks have gone under. More will follow.
As home equity values dropped and the stock market plunged, US consumers pulled back from their debt financed buying habits. That consumption which began a quarter century earlier, was the lynch pin for the global economy and the globalization which spurred dramatic growth in emerging markets. Despite stimulus here and abroad, with US consumers retrenching, the recession went global.
International markets are deleveraging by necessity. The Euro crisis, initiated by Greece’s funding problems, promised to derail the global recovery. Although Mediterranean waters are calmer now, that trauma has yet to be fully resolved. Likewise, the Chinese are working hard to reduce inflation without killing the growth engine required to feed and house a demanding population. The Fed has historically had a difficult time engineering soft landings. Even in a command economy, there is no assurance that the Chinese are any better at striking that balance. And Japan, which has yet to address its structural problems, could prove to be a focal point for global stress and potential shock. In fact, there are many other possible areas of concern, some yet to be identified.
The Great Recession, which began in 2007, is the result of extended debt financed consumer spending. That spending ignited global growth. Unwinding excess debt will take many years and have global consequences. It also means that fault lines in the global economy may have broad and sudden implications. Portfolios should be positioned for slow growth but also prepared for an additional shock that could come from any number of sources.