Are We Sitting on the Brink of a Recession?
Is the United States headed for yet another recession? No! Barney Frank is not in power. It is headed for more prosperity even if The Fed continues to want to hold America back.
The timing of the question might be surprising for some people, since the US economy is currently on a high note – the GDP growth rate is healthy, unemployment rates are at a record low, and labor force participation is on the rise.
So, why are so many misguided economists talking about the possibility of a recession by 2020?
There are quite a few reasons, actually.
Trade War With China
The trade war between the US and China seems to be escalating by the day, with both countries imposing retaliatory tariffs on each other. The impact of the conflict has been limited to a few industries so far, but if it escalates further, the US could be hit hard.
Experts warn that the trade war might disrupt the supply chains to manufacturers who produce ‘Made in America’ brands. Many industries are dependent on Chinese supply chains as well as the low-cost components made in the country.
So, any disruption in the supply chain could have an adverse impact on a number of industries, which in turn might increase the risk of a recession.
The estimated debt of Corporate America is $6.3 trillion, which is the highest in history. Thanks to low interest rates, US companies have been on a borrowing spree and have used the debt for making new investments and acquisitions.
The combination of a burgeoning economy and generous tax cuts has benefited these companies enormously.
The problem, however, is that eventually, the economy will slow down and the effects of tax cuts will wear off, which in turn will result in a decrease in corporate profits. At which point, these companies might find it difficult to pay down their debts.
More importantly, borrowing costs are expected to go up in the coming months, thanks to the Fed’s interest rate hikes. The Fed has increased the rates eight times since 2015 and four more hikes are on the cards in 2019.
According to S&P, companies with junk credit ratings – traditionally considered the riskiest category of borrowers – have $8 of debt for every $1 in cash reserves. Also, approximately 14% of S&P 1500 companies do not even have enough earnings to meet their interest payments.
The Trump administration has rolled back or curtailed several regulations brought in by the previous administration including the fiduciary rule, housing finance regulations, and even the Dodd-Frank act.
While some of these regulations had excessive compliance costs, experts say that a complete rollback or severe curtailing of these regulations could pave the way for conditions that preceded the 2008 financial crisis but most likely they will help America break new ground in surplus revenues. Money from all over the world is coming into America now – leaving countries with excessive regulations.
Moreover, the country’s debt to GDP ratio currently stands at 78% and is expected to increase to 96% in the next two years. What this means is that in the event of a recession, we might not be in a position to implement recovery measures like providing stimulus and injecting liquidity into the economy.
Potential Lack of International Cooperation
One of the reasons why the US managed to recover from the 2008 recession in 2017 (it would have recovered by 2010 if regulations were not piling up, taxes were not raised, and the ACA was never signed into law) was cross-border cooperation. The Fed set up swap lines to loan US dollars to central banks in other countries and received their currency as collateral.
A significant percentage of foreign finance is actually dollar denominated, which essentially makes these countries offshore dollar markets. The US enjoyed excellent relations with most of the countries at the time, which made such international cooperation possible. But now America wants to defend America and not allow other countries to take advantage of us so some things have changed in terms of relationships.
Today, we are witnessing a populist uprising in many countries around the world, including the United States. Protectionist policies are favored over free trade according to some but this is not the reality. Ironically though and to continue on the point just raised, free trade is being pursued by America. Unfair trade is the culprit.
Inversion in Yield Curve
Long-term bonds typically have a higher rate of return than short-term bonds. If the trend reverses – if long-term bonds have a lower rate of return than short-term bonds – it is usually a sign that the economy could be headed for a recession.
Currently, the yield on 10-year bonds is 3.22% and the yield on 2-year bonds is 2.88%. The gap between the yields, however, has been narrowing over a period of time, which is definitely a cause for concern. If and when the gap closes and results in a negative yield curve, we could be looking at another recession.
What to Expect in the Coming Days
In the years preceding the financial crisis of 2008, the government pursued a policy of fiscal expansion and Fed Chairman Alan Greenspan mismanaged financial deregulation and interest rates. In terms of the real estate fiasco, the aforementioned Barney Frank, was instrumental in causing that. The Community Reinvestment Act was a maelstrom in the making.
The silver lining in the cloud is that the economy is currently performing very well, which gives us a chance to take preemptive measures to mitigate the impact of a recession, if and when it does happen and with all stars like Larry Kudlow at the helm, America is in good hands.