January 25, 2016
Robert Samuelson wades into the turf on the explanations for the recent worldwide stock plunge in his column today. Most of what he says is actually pretty reasonable, but the framing doesn’t make much sense.
He starts the piece by citing the view of several forecasters that the drop in worldwide markets does not indicate a recession is imminent. But then he tells readers:
“But there is a less reassuring interpretation: The global stock sell-off may reflect gloomy prospects for ‘emerging-market’ economies. …
“If this theory is correct, then the worldwide sell-off of stocks represents a logical response to reduced economic prospects.”
It is not clear that these are in any way opposing views. Most forecasts had actually been for very slow growth even before the plunge in stock prices. In fact, we have been seeing slow growth (@2.0 percent) for the last five years. This is very weak for an economy that still has a long way to go to make up the ground lost in the downturn.
As I and others had noted, the stock market was priced high for an economy that was experiencing slow growth and likely to continue to do so for the foreseeable future, absent some major boost in demand. For this reason, the drop in markets from their 2015 highs is totally consistent with the growth projections that the Congressional Budget Office, the I.M.F., and other forecasters have been publishing. In that sense, the markets are not providing new information, but rather coming into line with the existing information we had about the prospects for economic growth.
The other part of Samuelson’s argument makes less sense. He tells readers:
“Oil companies have canceled $1.6 trillion worth of projects through 2019, estimates the consulting company IHS. The loss of these projects (and jobs) represents a drag on the global economy and, to some extent, justifies lower stock prices.”
Okay, losing $1.6 trillion worth of projects over the next four years sounds like a big hit. How large is it? Well, it amounts to $400 billion a year or roughly 0.5 percent of world GDP. That is not trivial, but we have to take account of the other side of the story.
If we assume this is based on a drop in the average price of oil of $60 a barrel from the level of 2 years ago, this corresponds to savings on oil of more than $1.8 trillion a year. If just one quarter of this ends up in additional spending than it more than offsets the hit to the world economy from less money being spent on oil exploration.
If half of the savings, still a conservative number, gets spent on consumption, it would amount to an additional $900 billion in annual consumption spending, more than twice the size of the hit from less spending on exploration. In short, there is good cause to worry about the environmental implications of lower oil prices, but the economic ones are positive for the world as a whole, even if some countries and regions will be very hard hit.
Finally, Samuelson gives us a line that we have heard before:
“The stock slump could be self-fulfilling. The Great Recession was a traumatizing event. Because it was so deep and unexpected, it made both consumers and business managers more risk-averse. With risks now rising and rewards falling, firms and households might cut their spending just a bit — and cause the very slump they’re trying to avoid.”
Actually there is no evidence that consumers and business managers have become more risk averse. Consumers are spending a larger share of their income than at any point in the last three decades, except at the peak of the housing and stock bubbles. If they have become more risk averse, it is not showing up in their spending.
The same applies to business managers. Investment spending as a share of GDP is back to its pre-recession level. It would be great if businesses would invest more, but why would we expect them to?
The source of weakness in the economy is the unmentionable elephant in the center of the room, the trade deficit. We have an annual trade deficit of more than $500 billion (@3 percent of GDP). This is a gap that must be made up by increased spending in one of the other components of GDP. (This is basic accounting – it is inescapably true. If you don’t like it, then you have a problem with logic.)
In the late 1990s we filled the hole in demand with demand created by the stock bubble. In the last decade we filled the hole in demand with demand created by the housing bubble. In the absence of bubble-driven demand we could get back to full employment with larger budget deficits, but that is not fashionable with the politicians and policy wonks in Washington. Therefore, we have to spin out wheels and pretend that the weak economy is a big mystery and come up with all sorts of convoluted stories like Samuelson’s about the trauma of the Great Recession.
One more thing, we owe our large trade deficits to the huge over-valuation of the dollar that we got in the wake of the bailout from the East Asian financial crisis in the late 1990s. This was all the doings of the Clinton administration, which directed the I.M.F.’s bailout of the region.
The failure of the bailout and bubble-driven growth path on which it set the country is why many of us cringe when they hear Hillary Clinton talk about turning to her husband for economic advice in her administration. The last thing we need is another round of bubble-driven growth.
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