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Skittish consumers, executives boost odds of new U.S. downturn

The U.S. economy is being choked by a crisis of confidence, increasing the odds of another recession.

After a stellar start to the year, a growing stack of indicators suggest something snapped in late spring and early summer, causing home buyers to retreat and executives to return to the safety of the sidelines.

Orders for durable goods rose a mere 0.3 per cent in July and purchases of new homes plunged 12 per cent to the slowest annual rate since records began in 1963, separate reports showed Wednesday.

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The fresh data adds to evidence that the world's largest economy stumbled badly toward the end of the second quarter, raising questions about whether the recovery can be sustained without fresh stimulus. Last week, new claims for unemployment benefits rose to 500,000, explaining the lack of demand for homes. On Tuesday, a report said that sales of existing homes plunged 27.2 per cent in July to the lowest rate since the National Association of Realtors began counting in 1999.

"The concern is that the economy is losing so much momentum so rapidly," said Paul Ashworth, senior U.S. economist at Capital Economics in Toronto. "In March and April, things were looking okay. Then, really for no discernible reason, the wheels have just fallen off."

Mr. Ashworth said his best explanation for the slump is the fragile psyche of American consumers and executives who remain shaken by the financial crisis.

With the unemployment rate at 9.5 per cent, there's little enthusiasm to spend and as a result there's little incentive for businesses to rehire and invest. Those who have jobs are plowing more of their incomes into savings as they seek to replenish wealth lost during the crisis. Lenders, facing tighter regulatory restrictions and an uncertain economy, are restricting credit, creating another barrier to consumption and investment.

The dilemma for policy makers is deciding whether they can bolster confidence with further stimulus.

Federal Reserve chairman Ben Bernanke, who is scheduled to speak at a conference in Jackson Hole, Wyo., on Friday, showed earlier this month that he is ready to toss a lifeline if necessary.

The Fed's policy-setting committee, led by Mr. Bernanke, said on Aug. 10 that it would continue to purchase a limited amount of Treasuries in order to keep downward pressure on interest rates, reversing a previous plan to get out of the debt market and begin the long walk back to a more normal policy stance.

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But "disappointing" economic indicators suggest the Fed will have to step up its Treasury purchases even more, Goldman Sachs chief economist Jim O'Neill said Wednesday.

"If we carry on with data like this, yes, it's coming," Mr. O'Neill said on Bloomberg Television, referring to a fresh round of asset purchases, an approach to monetary policy called quantitative easing because central banks increase the money supply by creating new cash and flushing it into the financial system.

"September might be a little bit soon, but by October I would say for sure, if the data carries on being as disappointing as it's been," he said.

The pressure to manage the recovery is on Mr. Bernanke because the political system is all but paralyzed. With midterm elections barely two months away, Republicans sense they can use the anxiety over the economy to help their campaign to retake control of Congress.

When lawmakers return from their summer break after the Labour Day weekend, President Barack Obama wants them to pass a bill that the White House says would help smaller businesses by offering tax breaks on investment and creating a $30-billion (U.S.) pool that the Treasury would use to make capital available to community banks. But co-operation appears unlikely. The Republicans have little to gain by working with Mr. Obama, and everything to gain by blaming him for the economy's woes. Earlier this week, John Boehner, the top Republican in the House of Representatives, called on the President to fire Lawrence Summers, his top economic adviser, and Timothy Geithner, the Treasury Secretary.

To be sure, predicting a double-dip recession in the U.S. remains the riskier bet. Mr. Ashworth puts the odds at less than 50 per cent as does Goldman Sachs. Nouriel Roubini, the economist who rose to prominence by predicting the financial crisis, said on Twitter Wednesday that the risk of a new recession was greater than 40 per cent.

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Investors appeared to tire of assuming the worst. The Standard & Poor's 500 index recovered from a 1.1-per-cent decline after the durable orders and housing data were released to close marginally higher along with the Dow Jones industrial average. The S&P 500 has fallen 13 per cent since its high for the year in April.

For Mr. Ashworth, the only cure for the current funk in the U.S. is time. Borrowing rates already are low, so there's little to be gained by the Fed resuming quantitative easing, he said. Instead, consumers, executives and investors might just have to get used to economic growth that likely will be sluggish for at least a couple of years, he said.

"Recoveries can be stop-and-start," Mr. Ashworth said. "This is clearly a stop."

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About the Author
Senior fellow at the Centre for International Governance Innovation

Kevin Carmichael is a senior fellow at the Centre for International Governance Innovation, based in Mumbai.Previously, he was Report on Business's correspondent in Washington. He has covered finance and economics for a decade, mostly as a reporter with Bloomberg News in Ottawa and Washington. A native of New Brunswick's Upper St. More

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