European debt crisis could jeopardize U.S. recovery, economists say

   The potential for another recession in the United States is relatively high, especially if the debt crisis in Europe causes the economy there to contract, according to two economists in the manufacturing sector.
   There is a 40 percent chance of a recession in the near future when the probability of negative growth at this stage of an economic recovery should be 5 percent, Daniel Meckstroth, chief economist for the Machinery and Allied Products Institute (MAPI), said at an economic forum hosted by the National Association of Manufacturers on Oct. 19.
   “We’re cruising at such a low level right now that it wouldn’t take much in the way of shocks to knock us back down,” Timothy Gill, director of economics at the National Electrical Manufacturers Association, said. He put the chance of recession at 35 to 45 percent.
   The assumption is that Europe is, or soon will be, in a mild recession that could gain momentum if there is a banking crisis in the European Union, the economists said.
   A freeze in credit and subsequent recession would have a negative impact on the United States because the global financial system is so interlocked and Europe is a major market for U.S. goods, experts say.
   European leaders have struggled for months to develop a rescue plan for Greece and shore up the Continent’s banks. U.S. bank exposure to the European banking system is $640 billion, or 5 percent of U.S. bank assets, and U.S. banks have $1.2 trillion in loans with German and French banks, which are the principle lenders to the troubled Greek and Italian governments.
   “This is really a slow-motion train wreck,” Gill said of the European debt crisis that has played out for the better part of the year. “My hope is that we can buy ourselves enough time for the U.S. economy to strengthen before the full impact of what’s going on in Europe really hits.”
   The crisis this week claimed its first U.S. victim. Bankruptcy hearings began in New York Tuesday for MF Global, an old stock trading house that had invested $6.3 billion in the debt of Italy, Spain, Portugal and Ireland – all of which have troubled economies and may need bailouts of their own.
   Concerns that Greece could default on its debt sharply escalated Tuesday after Greek Prime Minister George Papandreou made a surprise call for a referendum on its bailout package from the European Union, which includes highly unpopular conditions for Greece to cut government pensions and salaries, and raise taxes. Violent demonstrations have rocked Greece for weeks as European governments negotiated the rescue deal and observers believe a public vote is destined to fail. Reports from Greece said Papandreou’s own party is now in turmoil over the decision and that the prime minister sacked his military chiefs of staff.
    Stock markets reacted to the situation with a large selloff. The Dow Jones Industrial Average on Wall Street fell 297 points Tuesday.
   Both experts said the U.S. recovery will continue its slow, but uneven, pattern for a few years.
   “We just don’t see a lot of upside potential in the key drivers of the economy going forward over the next year-and-a-half to two years,” Gill said.
    He predicted that the U.S. economy would grow about 1.6 percent this year and the same amount in 2012. Unemployment, which is now at 9.1 percent of the available workforce, will edge down to 8.8 percent.
   He spoke before the Commerce Department last week released its preliminary estimate that Gross Domestic Product grew 2.5 percent in the third quarter.
   The manufacturing sector is still 10 percent below its previous high prior to the recession, Meckstroth noted. Corporate investment, rather than consumer spending, will be the primary driver of manufacturing growth. Companies will invest to replace worn-out assets and enhance productivity rather than to expand capacity, he said.
   “We project industrial production will not achieve its previous cyclical peak until the second quarter of 2014,” he said.
   On Tuesday, the Institute for Supply Management reported that manufacturing activity slowed down 0.8 points in October from the previous month. The survey of purchasing managers had a weak reading of 50.8 percent, based on scale where anything above 50 indicates economic expansion.
   Meanwhile, manufacturing inventories decreased 5.3 points to 46.7 percent. The index for customer inventories was 5.5 points lower in October than September at 43.5, indicating that respondents believe their customers’ inventories are too low.
   Sparse inventory levels suggest that production may need to pick up to keep pace with sales.
   The two economists said they expect manufacturing to outperform the general economy.
   NEMA is forecasting manufacturing output to grow 4.2 percent this year and half that in 2012. The sector’s electro-mechanical subset is expected to increase 6.6 percent in 2011 and 3.6 percent next year, Gill said.
   In addition to the moderate GDP growth during the third quarter, other positive economic signs in recent weeks have included higher retail sales and truck tonnage. Increases in motor vehicle production, tapering off of food prices, significant price reductions in gasoline, strong export growth and pent up demand for durable goods have kept the U.S. economy in slow-growth mode.
   Motor vehicle production will be up 14 percent this year and 6 percent next year, Meckstroth said. Jenny Lin, senior economist for Ford Motor Co., said there is strong pent up demand in the auto market with many older vehicles reaching their replacement age, some of which will scrapped rather than be resold.
   Construction spending increased by 0.2 percent between August and September but was down 1.3 percent compared to September 2010, the Associated General Contractors of America said Tuesday.
   The 2.5 percent growth in third quarter output was aided by a 16.3 percent arc in business fixed investment, with equipment and software up 17.4 percent and structures up 13.3 percent, according to Commerce Department data. Demand was strong for industrial and transportation, such as aerospace and heavy duty trucks.
   “The strong equipment-spending gains suggest that the need to stay competitive and improve productivity is driving companies to put some of their cash pile to work,” IHS Global Insight said in its weekly newsletter on Saturday.
   At the NAM forum, Martin Fleming, IBM’s chief economist, said that the growth opportunity is in rebuilding business infrastructure, especially in emerging economies. Forecasting services have estimated that U.S. fixed business investment will increase 8 to 10 percent in the 2014 to 2015 period.
   The conditions are in place for strong business investment, he said, including high capacity utilization rates for factories.
   But experts say that true recovery won’t occur until the housing market rebounds. People are still reluctant to invest in a new home because they are trying to get rid of existing debt, are experiencing stagnant incomes and are waiting for home prices to fall further. Meanwhile, the inventory of existing homes is still substantial and a drag on new home starts.
   On the positive side, more banks loosened than tightened lending standards in the third quarter, according to the Federal Reserve. And the number of homes entering the foreclosure pipeline is slowing, the Mortgage Bankers Association said.
   Meckstroth predicted housing starts will show a 4 percent increase in 2011 and increase 17 percent next year.
   The other primary risk besides the European financial situation is the political gridlock in Washington, both economists said. Meckstroth called the political gamesmanship over raising the debt ceiling last summer “completely irresponsible” because it could have put the country into default.
   Meckstroth’s forecast assumes that Congress will extend the 2 percent payroll tax cut used to pay Social Security that was approved late last year, but that is the only part of President Obama’s Jobs Act that will win passage. That will act as a necessary stimulus, without which economic growth will be much lower, he added.
IHS Global Insight said failing to extend the payroll tax cut and emergency unemployment insurance benefits from 2010 would create a 1 percent drag on the economy.
   Meanwhile, the congressional “super-committee” formed as part of a compromise deal to raise the debt ceiling has 22 days left to find ways to reduce trillions of dollars of debt, but so far there have been no signs of progress. The bi-partisan panel so far has been unable to identify the minimum requirement of $1.2 trillion in cuts. Without a deal across-the-board cuts, including those for the military and Medicare, will go into the effect. – Eric Kulisch