The economic recovery in the United States will be celebrating its 6th birthday in June. Despite the claims of many so called experts, investors and politicians, there is no legislation that can be enacted that will repeal the business cycle. The Great Recession in the United States which helped spark the previous international economic slowdown, officially lasted from December 2007 to June of 2009. Despite the policies of quantitative easing and massive stimulative spending on the part of the American government, there will be no reprieve from the coming and overdue economic malady.
The collapse in oil prices may have given a temporary reprieve to what is coming, but it will ultimately boil down to a number of factors that together will undermine economic growth in the United States and overseas. Brent the international benchmark for oil fell to $45.23 USD (United States Dollar) a barrel today, while in the United States WTI (West Texas Intermediate) fell to a new low of $44.21 USD.
There are some analysts that predict that sustained lower prices may well usher in a recession, because of the economic dislocation that the market is having on the energy industry. Although this may be true for a number of countries overly dependent on the export of crude oil, it will not be the case for most industrial nations. For these countries it will be a net benefit. This is especially true for many energy intensive industries.
The nations of Iran, Russia,and Venezuela, for example, were already in trouble both economically and financially before the plunge in oil prices. These nations on the whole need the price of crude to be near or in excess of $100 USD a barrel. This is impossible given the abundant international inventory of oil, caused by rising production and slackening demand.
There is a surplus world production of crude that is nearing 2 million barrels a day. Increasing production by Iraq, Russia and particularly the United States have helped to create this new reality. OPEC (Organization Of Petroleum Exporting Countries) refuses to cut production to help stabilize prices. This is a result of the claim made by core members of the organization like Saudi Arabia and the United Arab Emirates, that they would be surrendering market share if exports of crude were reduced.
International supplies of oil will eventually decline with the biggest drops in production coming from the United States (US). American shale drillers are producing oil at the fastest rate in 30 years. However, prices in the mid to low $40s USD are not sustainable for this type of production. Output is already leveling off and in 6 months it will be in full retreat. The decline in US production will equal most of the present glut in world supplies of crude. So one can predict a stabilization and somewhat recovery of oil prices, in the second half of 2015.
The only way to stave off the shale output decline in the United States now, would be an interruption in the production or export of oil from the Middle East region. This is always a possibility given the political instability in the area. There is also a slight prospect that the US government would enact a tax on gasoline, to maintain a higher price level overall. It would have the twin benefits of helping US producers of crude and raising new revenue for the government. Although the American federal government is drowning in debt and finding it increasingly difficult to fund and maintain infrastructure, new taxes are unlikely given the present political configuration. Additional tax money raised at this time, that would be earmarked just for a specific purpose or debt reduction although maybe helpful, would be somewhat unpopular with a public basking in the glow of lower energy prices.
Although a gas tax is still quite possible in the United States in a political deal, it is still highly unlikely that it would be large enough to change the fundamentals of the oil market at present. In addition, many politicians in the United States are unwilling to take away the stimulus that citizens are now receiving from lower energy prices overall. Future savings for consumers of gasoline alone, are estimated to be in excess of $75 billion in 2015.
Even though there are overall benefits to lower energy prices in industry and manufacturing, there will still be job losses as production begins to level off and decline. A number of US states that are dependent on shale production like Louisiana, Oklahoma, North Dakota and Texas, will experience an economic slowdown in 2015, if not a recession.
Other states who are not energy producers, will experience an overall net benefit from lower oil and energy prices. This will help sustain the economic expansion in the United States for much of 2015. Some analysts are predicting growth rates in excess of 3%, for the US in the coming year. Although this is quite probable in the first half of the year, it will become increasingly difficult to maintain if the global economy continues to under perform. The global economy is predicted to grow just 2.9% in 2015. It is also important to note, that many of the major trading partners of the United States are near or at recession levels in economic expansion.
Job growth in the United States reached a high of 252,000 in December. The expansion in jobs averaged 246,000 a month throughout 2014. The end of the year statistics brought the official unemployment rate down to 5.6% (the underemployment rate though is still 12.6%). The US government touts this as the best time in job creation since 1999. It also may well signal that the economy is nearing the end of a business cycle.
US GDP (Gross Domestic Product) growth is now at an 11 year high. In the 3rd quarter the US was growing at an estimated 5%. This is the highest rate since the same business quarter in 2003. GDP growth was 2.8% in 2012, slowing to just 1.9% in 2013. Although final figures for 2014 are not yet compiled, it is estimated by be 2.8%. Still, overall growth in this last business cycle has been quite lethargic until the 2nd quarter of 2014.
The official inflation rate in the US has averaged just 1.3% over the last year and interest rates remain at historic lows. The Federal Reserve (Central Bank of the US) is unlikely to begin with any interest rate hikes until at least April. When it does finally commence, the increases will be slow and measured. This will prove to be a detriment on the stock market, but it will be a temporary set back at most.
Wage stagnation
is the real problem for most of the country, and this has been the case during the entire period of economic recovery since 2009. The top 1% of wage earners have captured near 95% of the total economic growth in the US. Since the Great Recession, this same 1% has seen their incomes rise by more than 30%, while the rest of the population saw an earnings increase of just 0.4%. This widening gap, is creating distortions in the market place and lowers economic growth in the overall economy . Consumers as a result, have less money to spend on products and services, once the necessities of life have been paid for. This is why the present stimulus of lower energy prices are of major importance to the overall health of the US economy.
The American stock market is doing well, largely thanks to the policy of massive stimulus and quantitative easing that has been government policy since 2009. Since the low point in the spring of 2009, the Dow Jones Industrial Average and the New York Stock Exchange have increased more than 165%. The S&P has surged 200% and the NASDAQ is up by more than 250%. The stock market has breached the 18,000 level several times in late 2014 and early 2015. So an investor might ask,what is the problem?
The difficulty is that most of the recent growth in the market cannot be justified by the economic health of the economy. The overvaluation of many stocks cannot go on indefinitely. Sooner or later companies will need to report profits. Corporations cannot continue to support stock prices by cost cutting, repurchasing of stock, and dividend increases. These are all shorter term strategies.
Another explanation for the spectacular growth in stocks is that given the historic low rates of interest (0.25 Fed rate) since the onset of recession in 2007, where else can an investor place their money? More recently most commodities including oil, have tumbled in price and real estate has not fully recovered, since the collapse in the market in 2008 and 2009. Prices in this sector would have to increase an additional 20%, just to break even to pre-recession levels.
Interest rates paid by financial institutions are still negligible, leaving the stock market as the only viable alternative. It is therefore likely, that investors will continue to pour money into stocks in the first half of 2015. Expect market highs of 19,000 to 19,500 by the summer. Then in the third quarter, there will be a leveling off and the beginning of a decline, as economic realities begin to settle in. By the four quarter one can expect a major correction in the stock market, of at least several thousand points if not more.
As 2015 winds down and 2016 begins, expect the country to dip into recession. It will be difficult to avoid. The Fed will be unable to lower interest rates by much, since they will still be near historic lows. A new round of quantitative easing will also be ruled out, since that would lead to a collapse of the dollar. The national debt already in excess of $18 trillion USD and continuing federal budget deficits will make a major stimulus, highly unlikely as well. The unfunded government liabilities of over $120 trillion USD,will make further financial investments in the US government foolhardy.
The general economic slowdown overseas, will not allow the American economy to export itself back to health either. In fact, many nations including Europe, Latin America and Japan, will be in much more dire straits economically than the United States.
The US consumer already debt ridden and with 70% of the workforce still making less than reported in 2007 if one factors in inflation (15% rise since 2007), will be in no position to spend the economy back into positive territory. With 70% of the American economy still dependent on domestic consumer spending, the United States is due a major correction in 2016. The upcoming financial and economic calamity will no doubt become known in the future, as the Second Great Recession.