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Article Excerpt
DESPITE THE EXPECTED BOOST FROM hurricane reconstruction, demand for industrial metals could experience some turbulence in the next few years. "In general, the [global] economic environment is in the process of slowing," said Paul Kasriel, senior vice president and director of economic research with the Northern Trust Co., addressing members of the Metals Service Center Institute last month in Chicago.
The U.S. economy, which grew at a 4.6 percent pace in the first half of 2004, slowed to around 3.6 percent in the first half of 2005, and may well slow further due to the effects of the hurricane disasters in the Gulf Coast area.
"For some time--we don't know how long--the American economy will not be able to grow as rapidly. Katrina took out a lot of our energy production and distribution abilities, as well as transportation capacity, which will restrict the economy's ability to grow," said Kasriel. He added that about 25 percent of U.S. crude oil and natural gas production comes from the Gulf of Mexico. About 10 percent of U.S. petroleum-refining capacity is in the New Orleans area.
Kasriel noted that the index of leading economic indicators is up only 1.9 percent this year vs. 10 percent last year, indicating that the pace of economic growth is moderating. "The LEI is moving down, flashing some warning signals," he said. "If the Fed continues to raise rates, I think the LEI will flash those signals even more."
Housing and consumer discretionary spending will bear the brunt of the economy's slowdown, Kasriel said. Housing is very expensive today, relative to household income. In fact, housing affordability is at its lowest level since 1991, which suggests that housing prices could start declining.
Rising mortgage rates, and a slowdown in housing construction and sales, could dampen consumer discretionary spending, the main driver of the economy. "In recent years, a lot of people have been treating their houses as though they were their own personal ATM machines," Kasriel said. "As quickly as the value of the house goes up, people refinance, take out a bigger mortgage, and use the equity they extracted to buy a big screen TV or some other toy. Last year people took over $300 billion out of their houses." If real estate values begin to level off, homeowners will be less inclined to borrow their equity. "So households will have to increase their net worth in a different way--by spending less than they earn," he added.
When past generations retired, they tended to own their homes free and clear. Today's "McMansion" owner may still have a big debt when retirement rolls around. "How are we going to retire and pay the mortgage? My theory is we will become a nation of bed and breakfast proprietors, renting out our spare rooms to Chinese and Indian tourists, and driving them around in our SUVs showing them this great country of ours," he said, drawing laughs from the crowd. "So I think we will see a slowdown in consumer discretionary spending and a return to old-fashioned thrift going forward."
One big plus for economic growth in 2006 will be federal spending on infrastructure repairs in the South. "President Bush has essentially written a blank check for the rebuilding of the Gulf Coast," he said.
Optimistically, he estimated, the U.S. economy will grow about 3 percent next year, below the trend rate of 3.5 percent.
Meanwhile, the Fed remains concerned about inflation and is likely to continue its campaign of regular increases in the short-term rate, now at 3.75 percent. "The Fed is going to raise rates to at least 4 percent and perhaps beyond," Kasriel predicted.
He ended his remarks with a note of caution, warning that if the Fed pushes rates too far too fast, it could send the economy into recession because of the excesses in the housing market and high debt levels in the consumer sector.
Over 60 percent of bank loans are housing related, he noted. "If something goes wrong with the housing sector, something will go wrong with the banking sector."
Offering an international perspective, Joshua Mendelsohn, chief economist with Mendelsohn Global Economics, predicts global GDP growth should average from 3.0 to 3.5 percent in 2005 and 2006--down a bit from 2004's 4.0 percent, but still reasonably healthy.
Growth around the globe is far from uniform, however. "The pattern of growth remains unbalanced, with the U.S. and Asia, especially China, continuing to drive the world economy," he said.
The effects of the Gulf Coast hurricanes will cause some weakness in the U.S. economy for the balance of the year, but reconstruction should give it an offsetting boost in 2006. China's growth rate is expected to decelerate next year, but only modestly, to around 8.5 percent, which means the United States and China will continue to lead the world market.
Reflecting weakness in Germany, Italy and France, the Eurozone continues to under perform, with growth this year and next forecast at less than 2 percent. Japan's economy has shown signs of recovery, "but in both Japan and the Eurozone, slow and insufficient structural reforms are contributing to weak growth," Mendelsohn said.
Oil prices remain the key risk to the world economy, though prices should recede in the coming months as gulf oil facilities come back on line. Prices most likely will remain above earlier projections, however, due to such factors as speculation, concerns over developments in the Middle East, constrained production capacity and rising exploration costs.
So far oil prices have had limited effect on global...
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