‘Double dip’ – what is it? And what’s the risk?
“Double dipping” has a few meanings: drawing income from two (generally public) sources, putting your biscuit back in for a second dollop of dip, and when an economy slips back into recession after a short-lived recovery. None sounds fantastic, but it’s the latter that has us worried — particularly regarding the USA. Should it?
What is a double dip?
Worries about a double dip are common near the end of most recessions. But before we look at whether we should be worried about it, what is a “double dip”?
Economically, a double dip is when GDP (gross domestic product) growth slides backwards to be negative, after at least a quarter of growth. A “double-dip recession” therefore, refers to a recession that follows a short-lived recovery from a previous recession.
Why might it happen?
There are several causes, but these usually include a slowdown in demand for goods and services that’s directly attributable to layoffs and spending cutbacks from the last recession. There’s a fear things “might get worse again”, so people pull back.
In Australia, there’s been concern that once the policy stimulus wears off, growth will collapse again. One view has it that “now” is too early to talk about a double dip, because we haven’t emerged from this recession yet.
So what is the risk now?
There are 2 things to remember:
1. Talk of a double dip is very common towards the end of most recessions — take the early 1990s and in 2003, after the “tech wreck”.
2. They usually don’t happen.
There are, of course, noteworthy exceptions that make the rule:
- Japan’s back-to-back recessions in the 1990s
- the 1980s’ “W-shaped pattern” in the USA: the 1980 recession, followed by a brief recovery in ’81, then back into recession in ’82
- and earlier in the USA, when it went back into recession in the late 1930s after recovering from depression from 1934-36
Dr Shane Oliver, Head of Investment Strategy and Chief Economist at AMP Capital Investor, says each of these situations has one thing in common: premature tightening.
In 1981, the Paul Volker-led US Federal Reserve (“the Fed”), aggressively raised interest rates to squeeze out inflation. In the 1990s, Japan tightened fiscal and monetary policy before recovery became sustainable, and the USA did a similar thing in the mid 1930s.
Again this time around, many factors have been tossed around as potential double-dip drivers in the US economy next year, including:
- Monetary and fiscal policy tightening too early.
- A US dollar crisis.
- Rising unemployment cutting into consumer spending.
- The banking system being too weak to lend and potentially being hit by more shocks.
- Households being too weak to borrow.
- The potential for another oil-price-driven energy crisis.
- And, the “mother of all carry trades” that will soon come crashing down.
Let’s look at each one.
1. Monetary and fiscal policy will be tightened too early
This one, says Shane Oliver, is easy. The International Monetary Fund (IMF) and key governments have stressed the danger of premature tightening after studying the 1930s’ depression and 1990s’ recessions in Japan.
However, underlying inflation continues to fall and unemployment is very high, leaving neither the inclination nor necessity for premature tightening. This was most recently restated at the G20 finance ministers’ meeting, where they “agreed to maintain support for the recovery until it is assured”.
There is no doubt the markets could spin and turn when authorities do move to seriously unwind the extreme fiscal and monetary stimulus, but, that could be several years away. Similarly, new bank capital requirements agreed to globally will amount to monetary tightening, but the G20 has only agreed to implement them by the end of 2012, so 3 years away.
A related concern is that the recovery is solely due to monetary and fiscal stimulus, so will quickly fade once that stimulus is removed. Dr Oliver says this concern arises in most recoveries; however, it’s invariably the case that once the stimulus has “primed the pump”, stronger confidence takes over, making the recovery self sustaining.
A turn in the inventory cycle is also helping to drive this recovery, which can help fuel better confidence. (A quick explanation of this: inventories have an impact on economic recovery; for example, recessions are exacerbated when companies need to “fire sale” unsold stock, then after such sell-offs, the economy can grow quickly again when workers are called back to work.)
2. A US dollar crisis will force premature tightening
Talk of a USD crisis is common, but, says Shane Oliver, it’s hard to see a collapse occurring.
The two most traded alternatives (the yen and euro) are no more attractive, and both have similar — or worse — public debt problems and, arguably, worse economic prospects. Additionally, the Chinese won’t allow a sharp rise in the Renminbi.
Regardless, the Fed is not overly concerned about a weak dollar, given there’s no inflation in the USA. (Oliver says some observers fret about the Fed “printing money”, but until banks begin lending more, and economic activity and capacity utilisation return to more normal levels, inflation will stay a non issue.)
3. Unemployment will drag the USA back into recession
Unemployment is a serious problem in both the USA and Europe, but, says Dr Shane Oliver, it’s worth noting that unemployment invariably lags the economic cycle. In the USA, unemployment peaked 2 months after the 1982 recession ended, 15 months after the 1990- 91 recession and 21 months after the 2001 recession.
It lags because just as companies are slow to fire staff going into a downturn, they are also slow to hire in upturns (regaining confidence takes a while). The key point is that rising unemployment doesn’t keep economies mired in recession or trigger double dips, it is just one of the last indicators to turn.
That aside, a range of indicators suggests the US labour market is actually on the mend. Leading labour market signs — such as falling unemployment claims and announced layoffs, plus rising temporary employment and employment intentions in business surveys — suggest US employment will grow again early next year. This tells us the unemployment peak is close (although … it could also still go a bit higher).
It’s also very noteworthy that US companies may have overreacted in laying off workers. The past relationship between a GDP slump and unemployment rise suggests unemployment should have increased to 8.5-9%. Instead it reached 10.2% — possibly reflecting panic in all the talk of a depression. It could also mean companies will become short staffed more quickly than normal, so may be compelled to lift employment more quickly than normal.
4. Bank lending continues to weaken
Bank lending is continuing to weaken in the USA, and the US banking system is still far from robust. Even in Australia, lending to the corporate sector is still falling; however, says Dr Oliver, there are several points to note:
- As with unemployment, private sector credit growth normally lags the economic cycle. This was the case in both the USA and Australia after the early 1990s’ recession, with credit growth only picking up again a couple of years into the recovery.
- Medium to large corporates have been able to issue equity capital or access the corporate bond market to make up for reduced bank lending. It has been a lot tougher though for small business.
- Surveys by both the Fed and the European Central Bank suggest that banks’ willingness to make loans is improving.
- Consumers seem to be responding to fiscal stimulus and lower interest rates. This is clearly evident in Australia, but even America shows signs of life, with weekly chain store sales picking up, car sales improving and housing indicators bottoming out.
But what about another shock to the banking system? Dr Oliver cites 3 main risks:
First, many fret about a further collapse in the US commercial property market, but it increasingly looks like this market is bottoming. In fact, commercial property price indices for both the USA and UK showed modest value gains in the September quarter. So while bank losses are still rising on commercial property loans, they are also getting close to their peak.
Second, concerns of another wave of mortgage “delinquencies” as sub-prime mortgages issued in 2006 and 2007 come up for “rate resets” in the next couple of years. (This is where the low honeymoon rate ends and borrowers have to start paying a higher market rate.) While it’s hard to get a handle on how big this problem is, it’s likely the market rate may not actually be that much above the honeymoon rate given the fall in mortgage rates in the past 2 years.
Third, ongoing concerns that financial problems in Eastern Europe will drag down Western European banks. This is another issue that is hard to get a handle on, but IMF assistance seems to have headed off a serious default crisis in such countries. Happily, some countries (such as Lithuania), appear to be growing again. Also, the Western European banks involved are not as central to the global financial system as the big US banks.
5. There will be another energy crisis
This is always possible, but it is hard to see the oil price returning to last year’s highs, unless there is a much stronger growth recovery in advanced countries than currently expected.
6. It’s the mother of all carry trades
Dr Oliver says finally, it has been argued that equities, commodities, credit markets and other risky assets have only surged higher because the Fed and other central banks have pushed interest rates to very low levels that can’t last.
This is true to a degree, but it is exactly what the Fed and other central banks have been hoping to achieve — and is how monetary policy works. By cutting interest rates to very low levels, central banks have forced people into either spending or investing in more risky assets, and this has helped finance the recovery (for example, by making equity capital raisings easier) and has added to confidence and wealth perceptions, as asset prices have increased.
This is precisely what happens in most economic recoveries. It is also how most cyclical bull markets initially get underway before profit growth then kicks in and helps lead to a more sustainable phase in the recovery. In this sense, there is nothing unusual about the current surge in asset prices. While some asset prices may eventually be pushed to bubble-like levels, with shares, commodities and other risky assets still being below previous peak levels, we are a long way from that.
Conclusion
After the worst financial crisis and worst global economic slump in the post-war period, it is natural to worry about aftershocks that could trigger a return to recession. Dr Shane Oliver says while the risk can’t be ignored, a double dip back into recession next year is unlikely — particularly in the absence of premature monetary or fiscal tightening in the USA.
Sources: “Oliver’s Insights: What is the risk of a double dip?” by Dr Shane Oliver, Head of Investment Strategy and Chief Economist, AMP Capital Investors; “Double Dip Recession”, Investopedia; “Economy in free fall in fourth quarter”, MarketWatch; IndustryWeek; and “The Macquarie Dictionary”.