Friday, June 20, 2008

Economic Outlook for the US: 2008

Well, first quarter growth, while weak, was a little bit better than expected. The economy grew at a .9% pace, as opposed to the .6% pace of previous months. If the 2001 economic slowdown is any indication, the US should avoid a recession. Even the Fed has apparently decided to stop its aggressive interest rate cuts, opting for a “wait and see” approach to see how the economy handles the various stimulants that have been injected into it over the past half a year.

Unfortunately, we are FAR from out of the woods. GDP growth was largely carried by inventory build-up by businesses, rather than actual consumption growth. In fact, personal consumption grew barely, and mostly on non-durable goods (which people would buy up if they were confident their incomes were growing). So, demand isn’t holding up that well. And we shouldn’t expect it to, either, as incomes lag, people start saving more, and gas prices continue rising.

What happens when demand starts falling? That means that US companies, two-thirds of which are considered are junk debt now, are going to be struggling to pay bills. That means a lot of fold-ups, and a lot less business investment (especially since bigger companies are going to prefer to buy these cash-strapped smaller companies and their assets, as opposed to new investment). Lower returns for them also means problems for the banks that are relying on those payments. And that means more trouble in the financial sector, which is in turn going to keep a clamp on lending for the foreseeable future.

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