Downturn remains real possibility

By Mark Weisbrot
knight ridde/tribune
WASHINGTON -- Will the U.S. economy do as well in 2006 as it did in 2005? That may well depend on whether we can make it through another year without any of the current economy's big imbalances and unsustainable trends coming back to bite us. The median forecast for Gross Domestic Product growth in 2006, according to Bloomberg News' latest survey of 71 economists, is 3.4 percent. This is a little less than estimates for 2005, although a significant slowing from last quarter's 4.1 percent annualized rate.
But economists are notorious for not forecasting downturns in the economy. And there are a number of imbalances in the U.S. economy today that, when they provoke the inevitable adjustment, could send the economy spiraling downward.
Dangerous bubble
The most important of these is the housing bubble. House prices have increased by about 55 percent, after adjusting for inflation, over the last eight years. This is an unprecedented departure from their long-term trend -- from the early 1950s to 1996, house prices increased at the same rate as overall inflation. The reason for the vast run-up in house prices is a speculative bubble -- the same kind of frenzy that drove the stock market bubble in the late 1990s.
When the stock market bubble began to break in 2000, it caused the recession of 2001. The housing bubble has driven the economic recovery from that recession, and has been responsible for most of the job creation since 2001.The housing market is already cooling, and when the bubble bursts it is very likely to cause a recession.
Our record trade deficit is another unsustainable trend. We are now borrowing about 7 percent of our GDP from abroad. At some point this will have to adjust, and the way this happens -- unless we have a serious recession -- is for the dollar to fall.
A fall in the dollar could also cause the Federal Reserve to raise short-term interest rates more than it should, since rising import prices add to inflation.
The economic recovery has also been driven by consumption, financed by enormous levels of borrowing. Last quarter the household savings rate was negative for the first time ever. This rate of borrowing and consumption is also unsustainable. It is possible that business investment could pick up as consumer spending inevitably slows. But business investment as a share of the economy is still far below its level of 2000.
Unfortunately most Americans even in 2005 did not fare as well as the overall economy. Wages have lagged behind inflation, which means that most people actually lost ground. And this does not include increases in the costs of health insurance and co-payments.
That's why most Americans are not as pleased with the economy as Wall Street has been lately. And our 5 percent unemployment rate, which looks relatively good at first glance, is misleading. If we look at the employment rate instead we find that it is about 1.7 percentage points lower than it was in 2000. This corresponds to about 3.4 million fewer jobs, because people have quit the labor force.
So a 2006 economy that repeats 2005 wouldn't be all that great. Unfortunately, given the economy's current imbalances, we'll be lucky to get that.
X Mark Weisbrot is co-director of the Center for Economic and Policy Research, Washington, D.C. Distributed by Knight Ridder/Tribune Information Services