Expecting Continued Dollar Weakness, US Recession

The next six months will show how well the world economy and the U.S. economy can perform without a strong contribution from U.S. consumption growth. The credit- and housing-fueled growth of U.S. consumption at a persistent 3 percent rate over much of the last several years will not continue and could turn negative in coming months. Meanwhile, U.S. capital spending will also probably slow, as will spending on non-residential construction. A U.S. recession is likely, despite the Fed's move to address lower growth by cutting interest rates. The Fed's initial easing move usually coincides with the onset of a recession. Weaker global demand growth will be exacerbated somewhat by the continued weakness of Japanese consumption, but that is not a new factor.

The adjustment process--global rebalancing--will include continued dollar weakness and a fall in U.S. consumption, invariably a sufficient condition for a U.S. recession. For some exporters to the United States, the combination of a weaker dollar and slowing U.S. demand growth will sharply curtail exports and thereby slow the growth of export-driven economies. For overheating economies like China's, this is probably a stabilizing factor that could be made more so if the Chinese were to allow their currency to appreciate more rapidly. For European exporters, problems may also arise in view of the ECB's unwillingness to cut rates and the modest growth of demand in Europe. Spain's housing sector is due for a sharp correction. Emerging markets may also experience slower growth in the face of a weaker dollar coupled with slower growth of U.S. demand for their exports.

The generally robust global economy outside of the United States--with the exception of Japan--can and should help to cushion the U.S. growth slowdown by continuing to enhance the growth of U.S. net exports. It is to be hoped that that process will not be impeded by increasing protectionist pressure in Congress, which would prove counterproductive. Broadly, it is important to remember that the global economy is achieving a much-sought rebalancing away from dependence on U.S. demand growth and large U.S. trade deficits and toward more dependence on global demand growth and lower U.S. external deficits. That said, the process may not be as painless as some have imagined.