The current consensus among American policymakers and commentators, including Federal Reserve Chairwoman Janet Yellen, is that the U.S. economic recovery is well underway. A recent survey by U.S. Federal Reserve has shown a solid growth in the U.S. economy, prompting some economists to raise concerns about too rapid a recovery and the resulting risks of inflation.
But not everyone agrees with this assessment. One firm in particular, the Jerome Levy Forecasting Center, a New York–based economic consultancy, warned that the world economy might plunge into another recession in 2015 that will take down the U.S. economy with it. It is hard not to take this forecast seriously. Levy economists, who use the profits perspective forecasting model developed by Jerome Levy in 1908, have accurately predicted every major financial event in the past few decades, including the 2008 financial crisis, which many mainstream economists said was unforeseeable.
The Levy Center says policymakers and commentators are not paying attention to a key trend in the global economy: the fall of investment expenditure in emerging market economies. The following chart shows investment expenditure for the Levy Center’s emerging market aggregate.
The emerging market aggregate consists of 18 countries: Argentina, Brazil, Chile, Colombia, the Czech Republic, Hungary, India, Indonesia, Malaysia, Mexico, Peru, the Philippines, Poland, Romania, Russia, South Africa, Thailand and Turkey. As shown in the chart, investment expenditure, a key driver of economic activity, has been slowing down in these countries for more than two years. Some analysts appear to assume that this slowdown of investment spending is due to weak growth in developed countries. They imply that exports and investment in the developing countries will increase when growth picks up in the developed countries.
The Levy economists, however, say this analysis is mistaken. They contend that the emerging market economies have become too large to continue to rely on exports to the developed economies. Besides, the share of exports from emerging markets to the developed economies has stagnated after many years of growth. The key driver of the emerging market economies has been massive amounts of fixed capital investment in buildings, factories and machines. The Levy economists say this has created a massive overcapacity problem, meaning these economies now have nowhere to offload their products. As this trend becomes evident, firms in the emerging market economies will eventually pull back on investment spending — leading to recession.
How does this square with the positive outlook of U.S. policymakers and commentators? The Levy Center has been forecasting that the U.S. economy will grow at reasonable levels through the latter half of 2014 but the structural problems in the emerging market economies will change this calculus beginning in 2015.
“The worst reasonably likely scenario involves a steepening profits decline that triggers recession early in 2015,” the group wrote in its July newsletter. “The best reasonably likely scenario is a modest profits rise starting in the fourth quarter and continuing to mid-2015 before profits begin to fall.”
The researchers put the likelihood of the U.S. experiencing recession in 2015 due to a slowdown in the developing economies at 65 percent. If not next year, they say, the downturn will occur in the coming years.
A decision by the Chinese Communist Party to increase investment to counteract an economic downturn in China could forestall a recession in the developing economies that could spread to the rest of the world. The Levy economists point to a 50 percent year-on-year increase in the number of projects approved by China’s central planning administration. This rise in investment expenditure may lead to China’s importing more goods from the other emerging market economies, and this may keep them from ticking over. But the Levy Center also notes China’s massive overcapacity problems, especially in housing, and how this will eventually unravel, so even if China manages to delay recession in the emerging market economies, it cannot prevent the slump altogether.
U.S. policymakers appear not to recognize these concerns. Last month Yellen suggested the U.S. economy might be expanding too rapidly because of “pent-up wage deflation.” Her argument echoes conclusions published by the Federal Reserve Bank of San Francisco in an academic paper in January. The Fed argues that wages were not lowered enough during the recession and thus the current slow wage growth is in fact not a sign of weak recovery. Instead the slow wage growth reflects the lack of pay increases for employees since wages did not fall enough during the recession. This assertion was quickly refuted by economists at Goldman Sachs using very simple empirical measurement that showed sectors with below-average wage decline in the recession are now registering above-average wage acceleration.
In the end, the debate underscores the U.S. policymakers’ and commentators’ failure to grasp complex real-world economic interactions. They have once again become hypnotized by their overly simplistic, abstract models, which exposed their failure in 2008. This generates a rather bizarre argument about what constitutes slow wage growth. Meanwhile a storm that could tip the world back into recession seems to be gathering in the emerging market economies. It is perhaps time to listen to and engage with the economists who saw the last crisis coming. If these self-reinforcing tendencies within the profession continue, it seems unlikely that we could effectively face down future economic problems.