THE BOTTOM LINE: Monitoring the U.S. slowdown

Everybody agrees that the U.S. economy is slowing, but by how much? Are we looking at a nice, soft landing, a bumpy landing, or a crash? The answer matters a lot, but it is complicated.

The issue comes down to the behaviour of the U.S. consumer, who is responsible for over 70% of the spending in the U.S. economy and more than 15% of all the spending in the world. The U.S. consumer has been on a tear for years, spending all income received, borrowing to buy houses and cars, and refinancing mortgages to take equity out of rapidly-appreciating homes.

All this has meant a negative rate of saving for consumers, which is unusual to say the least. It has also meant a record level of consumer indebtedness. Indeed, U.S. consumer indebtedness as a share of income has set a new record almost every year for the past 25 years. Some of this growth in recent years can be attributed to ultra-low interest rates, of course. But spending, especially on houses, was given a significant boost by the events of September 11, 2001.

The terrorist attacks of 9-11 reminded Americans that life can be short. There is not much point in carrying a lot of savings if the future can be shortened so randomly. Households have responded by living in the moment, buying homes sooner in their life-cycle, and feathering their nests.

It is against this backdrop that we must consider the current housing downturn and what it might mean for the U.S. consumer. Higher interest rates and flat or falling housing prices have taken a lot of potential gains from mortgage refinancing off the table. This could mean as much as $250 billion less consumer spending power in 2007. Against this, though, is the fact that solid wage growth will put an extra $200 billion into consumers’ pockets in 2007. Lower gasoline prices will also boost spending power. In other words, the loss of mortgage refinancing opportunities could be approximately offset by other rises in spending power on a mechanical level, all looks well.

But that leaves the more fundamental issue of how much Americans will save in a more uncertain economic environment. During the big slowdowns in 1980-81 and 1990-91, the saving rate rose by 1-2%. If the saving rate were to rise by 2% in 2007, U.S. economic growth could slow to as low as 1%, much lower than expected, with the attendant effects on Canada and the rest of the world.

The question is, what will be the psychological effect of the popping of the U.S. housing bubble? When American consumers see media reports suggesting that their housing market has crashed, imploded, or giving other extreme descriptions, will it encourage them to keep borrowing and spending money? Should we take seriously the possibility that five full years of post-September 11 experience may have dulled the fear of terrorism, and made the future look longer, in which case there might be an even greater shift toward penny pinching than in the last two recessions?

The bottom line? No one can project how U.S. consumer psychology will adjust to this new environment. But Canadian companies need to position themselves for slower growth, and should at least consider how they would deal with the outside chance of a U.S. recession.

Stephen Poloz is Senior Vice-President, Corporate Affairs and Chief Economist, Export Development Canada. His column on trade-related issues appears weekly on www.ctl.ca