CRN Interview: Recession Very Likely, Prominent Economist Says

In an interview with John Roberts, CRN director of editorial research, Shilling gives his 12-month economic outlook, gauges the economic impact of energy prices and global political unrest, outlines future trends in interest rates and business capital spending (including IT investment) and looks at the role of overseas outsourcing in technology.

CRN: What's your overall assessment of economic conditions for the next 12 months, particularly growth and business investment?

SHILLING: The economy is slowing, and I suspect that by the end of the year it could very well be in recession. The basic reason is that housing activity is weakening, and that has been the mainstay of consumer spending, which in turn has been propelling the economy. During the past 17 quarters of expansion, spending growth has exceeded income growth by 2.5 percentage points on average, on an annualized basis. And housing is what has been supporting that, with people pulling money out of housing by home equity loans or refinancing. Homeowners have been reasoning that their house is a continually refilling piggy bank, so they can borrow more on their credit cards or save less because their nest egg--all their saving requirements--is taken care of by that house.

CRN: Something on the order of $600 billion in home equity has been taken out by consumers in the past couple of years.

SHILLING: That's right, and that is what is sustaining consumer spending, which accounts for 70 percent of GDP. Once consumers see that housing price appreciation is no longer the order of the day, then they are going to curb their spending, as they basically have no alternative. Construction and mortgage brokerage and all of what is related to it has accounted for about a third of the job creation so far in this expansion. If you wipe that out, you're taking a big check out of your economy. And housing prices don't even have to decline. If they simply level off, you have got a lot of people in trouble. And because we are essentially buying the world's excess goods and services, if U.S. consumers get into trouble, then you not only have a recession in this country, but also a global economic turndown.

CRN: What's your take on business investment in the coming 12 months?

SHILLING: A lot of people have looked on this as the "great white knight" that's going to ride to the rescue and pick up the slack in consumer spending. But two things are important here. One is that business investment [in software and hardware] has already been quite strong. If you look at the last couple of years, it has been growing at about a 10.5-percent annual rate. That's not markedly different than the 12.5-percent growth rate back in the late 1990s, during what was clearly an overblown capital-spending boom. So the first point is that in investment spending, the growth hasn't been all that weak.

The second point is, what do you do for an encore? You still have a lot of excess capacity left over from the late 1990s boom. My favorite example is fiber optic capacity. At the bottom, 3 percent of the existing capacity that was put in place in the late 1990s was being used, and now the figure is only about 5 percent of capacity. This is admittedly an extreme case, but there's a lot of capacity left over. So how much can you expect investment to grow from here to really spur the economy? Moreover, to make up for the consumer spending component I cited earlier, investment would have to grow at a 30-percent annual rate, and that is just not in the cards. So this idea of capital spending rescuing the consumer is not realistic.