Goldman Sach´s Chief Economist, Jan Hatzius, believes the U.S. is experiencing a healing process, especially in the private sector, which has fairly limited leverage. But the bank can not rule out a new rating downgrade this year for U.S Debt.
So, first of all, I would like to know in a general perspective, how is the US economy right now? Are we gonna see a strong path recovery, or are we still at risk of falling into a recession in 2012?
I think we're seeing a healing process in the economy. We've made quite a lot of progress in that healing process, in the private sector in particular. So the private sector has brought down its leverage quite a lot. It's been running a very large financial surplus. Income exceeds expenditure by six percent of GDP. That's a big number. That's been true for a couple of years, seeing large surpluses for a couple of years. And that's brought down leverage in the banking system; it's brought down leverage in the corporate sector; and it's brought down leverage in the consumer sector.
We're also seeing healing in the housing market. We think that housing has probably bottomed, as far as housing starts are concerned, and we expect housing to bottom in the next year, as far as prices are concerned. So all that is pretty good news.
Having said that, I don't think we're going to see a strong recovery in 2012. The process is still ongoing, and there are some headwinds. The healing process itself, in a sense, is a headwind. And those headwinds, we think, are going to keep growth positive, but relatively weak, only about two percent in 2012 as a whole.
And if we take a look at what's going on in Europe, what's the relationship, and what's gonna be the impact for the US economy if, by any chance, we see Greece defaulting or we see any of the members going out of the Eurozone countries area? What could be the possibilities right now with Europe going into a collapse?
Right. So I'll tell you our baseline, and then I'll talk about the risks. The baseline is a significant recession in the Eurozone, obviously much more in some places than in others, so a fairly deep recession in Spain, Italy, obviously Greece − Greece is in a separate category − but a fairly deep recession there and, essentially, a few quarters of stagnation in Germany and France, so not a deep recession, but more of a pause in economic activity with overall GDP in the Eurozone as a whole declining by a little less than one percent in 2012. So that's the baseline.
Under that baseline, we get spillovers into the US, maybe up to a percentage point, through basically three channels: direct trade impact - that's a small channel because the US doesn't really export much to Europe - changes in financial conditions through the currency, probably first and foremost, and potentially through the equity market. That's maybe a few tenths of growth, although it always changes, depending on how the financial markets do.
And then, No. 3, linkages in the banking system, so exposures of US banks to Europe and activities of European banks or the subsidiaries of European banks in the US. And that could be another few tenths of a percentage point. So all of that is the baseline that's included in our forecast in the US.
If we were to see a lot more turmoil in Europe and a disorderly default in Greece, let alone countries actually leaving the Eurozone, then we probably would see a bigger impact in the US because that's definitely not part of our baseline.
And do you think there's any lessons that Europe can learn from the US and vice-versa?
I think so, I think in the sense that the US went through a more fundamental crisis than Europe did in late 2008. I mean, there was a crisis everywhere, but in the US, it was more systemic. There was more feedback between the financial markets, the banking system, the real economy, and the housing market.
And you had a lot of feedbacks going in both directions where deterioration in the real economy led to deterioration in the housing market because people lost their jobs and defaulted on their mortgages, and that led to greater stress on the financial system, and that led banks to tighten credit standards, which fed back into the real economy.
And, once those feedback loops had really started to get going, it took a very large effort from the authorities to stabilize the situation. And that effort meant not just stabilizing the financial markets in isolation, but also trying to stabilize the real economy and focusing on the impacts to the real economy from government policy, fiscal policy, as well as monetary policy.
Now, I think Europe is in a comparable situation in the sense that there are also some very significant feedback loops between economic activity, government bond markets and budgets and the financial system. And Europe's clearly done a lot. I mean, the ECB has done quite a lot in terms of providing liquidity for banks across the Euro area.
But I think where we have not seen as much has been in terms of focusing on economic growth. And economic growth is ultimately important to really stabilize the situation. If the economies continue to contract, then it's going to be much more difficult to stabilize budgets and stabilize financial systems. And I think that may still require more easing from monetary policy, probably mainly through non-standard measures, but that's one area.
The other area, frankly, is to think pretty hard about the amount of fiscal restraint in the short term that is constructive for reaching the long-term budget goals. So we've done some research that looked at the optimal pace or the sort of speed limit for fiscal consolidation. And we basically found that once you get beyond a two percent of GDP adjustment in the structural balance per year, once you get beyond that, there's a risk that fiscal restraint actually becomes counter-productive, not only in terms of weighing on the economy, but even in terms of the budget outcomes.
And so our focus, therefore - and this is a little bit of a US perspective, but I think it's what we've also learned in the US in the last few years - would be to commit to longer-term fiscal consolidation, but not necessarily impose quite as much austerity on the countries that are currently in the crosshairs, as we've seen in some cases.
So, I mean, again, Greece is the extreme example. But you have seen a very large amount of fiscal restraint, and you've got an economy that continues to contract very rapidly, so clearly, it's not working very well there.
And then going back to the US, I would like to talk about employment or unemployment. We have seen such not bad numbers lately, but I would like to know if this is just a seasonal number, or if it's just people that are giving up, and that's why we have seen the unemployment rate going down to a point.
I mean, I think there are basically three components of the improvement. I think some of it is just a better, I think, a better outcome for the economy than I think most people would have expected three months ago. So growth generally in the fourth quarter seems to have been quite a bit stronger. We currently think a little over three percent annualized, so that's part of the improvement in the labor market.
The second component is a drop in labor force participation, which has pushed down the unemployment rate. This is not an issue for the other labor market indicators. There is definitely ongoing decline in labor force participation, and that has pushed on the unemployment rate, and it probably still hasn't quite stopped.
And then the third point is that there probably are some seasonal distortions. There's been some help from weather. You know, it's been a very warm winter, for the most part so far, and we also probably are getting some distortions from the sharp decline in economic activity after the Lehman default. So what happened in late 2008, the very sharp decline in October, November, December 2008, has probably affected, to a degree, the seasonal factors that are being used to adjust the labor market and other activity data.
Also, do you think that there's still room for consumer spending to grow in 2012 after what we've seen last December?
I think we'll see more consumer spending growth, roughly in line with income. So we have no major changes in the saving rate in our forecast.
I'm also a little skeptical in the reported decline in the saving rate that we've seen over the last six to nine months. I suspect that at least some of it is probably due to statistical distortions because it's always good to remember that saving is the small difference between two very large numbers; namely, income and expenditure. And if you've got any statistical errors in either income or expenditure, that's going to result in potentially large moves in the saving rate, so I think we probably had some of that.
But we expect slow but steady growth in consumption. Generally, the consumption data have been okay. They were a little stronger than expected a few months ago and have been a little on the softer side more recently, but overall we are seeing moderate growth..
And the housing sector, you said that we are gonna touch bottom this year?
Very, very U-shaped, extremely slow. There is a big difference between housing cycles and equity cycles. So if you have an equity bear market, once the decline is over, typically you see a sharp recovery. Once the selling, in a sense, has played itself out, you get a V-shaped recovery.
In the housing market, housing markets look very different. Once the selling is over, once the declines in prices are over, typically, you get a period of stagnation and only then a very gradual upturn in prices. And the reason is basically that equity markets have a lot more price transparency and adjust much more quickly because they are centralized, super transparent. Everybody knows what they're transacting; whereas, housing is decentralized, not very transparent, much more driven by individuals who are maybe not always so well informed about what their house is truly worth.
All of those things just basically extend the cycles, both on the upside and on the downside. So our expectation would be a bottoming in 2012, then basically stagnation in 2013, and then by 2014, 2015, gradual move towards price increases that then gather pace and that accelerate in the second half of the decade, but probably not for a couple of years.
And with all the situations of the US economy, has the Fed done enough, has room to do anything else?
We think they'll do a little more. We think they'll probably do QE again sometime in the first half of this year. That is obviously partly dependent on the economic data, but under our forecast, it makes sense to do a little more, especially given that they currently have an asset purchase program underway, Operation Twist, selling short-duration, buying long-duration treasury securities. And that is scheduled to end in the middle of the year.
And I suspect that they're going to want to replace that asset purchase program with another asset purchase program. I don't think they're gonna want to stop buying altogether. And if they replace it with something else, QE's really the only option because they can't do more Operation Twist because they will have sold basically all the short-duration paper on the balance sheet. So the only way to keep it going is essentially by financing it via additional excess reserves. So we think we'll see it a little more.
And then let's go to Washington for a moment. We're seeing the debt ceiling limit approaching again. Do we see any risk of another downgrade for the US in the next year?
I mean, it's possible. Clearly, this is not something you want to rule out, given the potential, you know, the various potential for partisan discord and fiscal negotiations and election. The debt ceiling issue itself, we think, is probably not going to be as big a deal because it probably won't really hit until after the election. If it happened before the election, that would be a big problem, but we think that's pretty unlikely, given the way the budget numbers are coming in.
The one other thing I'd say about rating agency downgrades of sovereign borrowers is we've now had a few. So far, I mean, it's not - it doesn't seem like it's a big predictor of what happens to yields. I mean, the most spectacular example of that, of course, is the US downgrade back in August. But, of course, it's not something you can rule out.
And what do you think that Washington or the White House needs to do to create a certain equilibrium with their accounts and to put everything ? their house a little bit in order?
I mean, the main issue really is long-term - there's a very large projected long-term deficit, which is primarily due to the cost explosion in the health care system. So if you look at the long-term projections of the congressional budget office, what they call their alternative projections where they're not bound by current law, but they actually put in numbers that are perhaps more reasonable than continuation of current law, you get a very large deficit in the next few decades, almost all driven by increases in health care costs.
So there's a question basically whether the country should accommodate those increases in health care costs by increasing taxes − you do need to increase revenue a lot if you want to accommodate this - or whether you find ways of making the health care system less expensive, which probably would mean restricting access among, you know, especially in Medicare, Medicare being the single biggest issue. And that's a big political question, which I think is going to dominate the next few decades.
I mean, I'm a little less worried about the short-term deficit because, for me, the short-term deficit is mainly the flip side of the deleveraging in the private sector. So there's a dedicated source of financing, in a sense, for the short-term deficit. And as long as the private sector continues to repair its balance sheet, the private sector's going to want to pay down debt and/or accumulate safe financial assets, so I think you can stay in an environment where you have a pretty large deficit still, but nevertheless, a low level of long-term rates.
Now, from a policy perspective, what would I like to see? I think a longer-term commitment to a fiscal rule, I think, would be helpful, a longer-term commitment to fiscal sustainability and small deficits, sustainable deficits, I think, would be helpful. But I think there's also risk - I would not want to see a large amount of fiscal retrenchment in the short term because I think the economy - it's too early from the perspective of where the economy is.
And what do you think about the proposal of increasing taxes to rich people that Obama has put on the table?
So that's ultimately going to be more of a political question, I think, you know, how you want to raise revenue. Eventually, you are going to probably have to raise revenue, as well as cut spending. You probably will need a bit of both.
But, again, how that works, whether it comes through income taxes, whether it comes through the top rates, whether it comes through changes in the sort of lower and middle income areas, or whether it comes through other types of taxes, such as introduction of a value-added tax or higher energy taxes, again, that's really more of a political issue.
We've been hearing about some states possibly or cities or small towns going bankrupt, not having their budget accounting in order, having huge deficits. Are we gonna see any problems during this year in that area?
Generally, I think the problems are the adjustment has progressed pretty far. I mean, you have a system in all but one state, virtually everywhere, where the operating budgets need to be balanced, which means that you don't really have much room for responding to cyclical deterioration and tax revenues. You have to essentially cut the budget in an environment in which the economy may be quite weak.
So, in 2009, 2010, there was a lot of budget cutting. That has a drawback, and the drawback is that the states and municipalities thereby exacerbate the business cycle, and that definitely has been a problem, but it also has an advantage. The advantage is that you get done with bringing the budgetary house in order in the states and in the municipalities at an earlier stage.
So, because of these rules, the states are much further along than the federal government in adjusting, so I think that most of that adjustment probably lies behind us. There may still be a small negative impact on GDP growth from cutbacks in state and local spending. There probably will be some more reductions in employment in the state and local sector. But I don't think it's a major macro issue for 2012.
And when is the US gonna start picking up a strong growth and recovery?
You know, I think even 2013, it's not clear if even 2013 is going to give you strong growth. Yes, I the private sector I think 2013 will be stronger than 2012. But 2013 is also a very natural time for seeing some fiscal retrenchment. It's after the presidential election, and there are a number of measures that are scheduled to expire at the end of 2012. So you've got the Bush tax cuts expiring. You've got the payroll tax cuts probably expiring, assuming it gets extended for all of 2012. You've got the unemployment benefits expiring with the same assumption. And you've got the automatic spending cuts that are supposed to kick in, in early 2013, the sort of counterpart to the fiscal commission or the super-committee not coming to a decision.
So, if you - if all of that were left to take effect, you would get a very large negative impact on growth. We don't think that's going to happen, but even if only some of it takes effect, you still get a reasonably sizable negative impact on growth. So that makes it a little tough to expect a really strong pickup in growth in 2013. But, beyond 20143, maybe the outlook gets a little better.
But, I mean, we've seen a slow recovery. Recovery's continued. We think it probably will continue, but we don't think it's going to be as rapid as we'd like to see it.
If we see a hard landing in China, how is that going to affect the US?
I mean, I think the US is not that exposed on that to China, in the sense that the financial linkages are pretty limited. And China, of course, is very important for global commodity markets. And the US is very dependent on global commodity markets. So if you saw a hard landing, a sharp slowdown, let's say, in China, then you probably would get some direct negative effect on the US via reduced export demand, but also some positive effect to offset that via lower commodity prices.
And I don't think that there would be necessarily a large net effect on the US. I mean, if you make it a very hard landing, much harder than anything we would expect, I mean, in that case, maybe things - maybe the impact would start to get a little bigger or, at least, harder to predict. But, in general, it actually seems to us that the US is not as exposed to China because of this commodity linkage.
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