7/2/2009
By Carlos Guillen, Semiconductor Analyst

While we still believe that the economy is worsening at a decreasing rate and that it should reach a trough toward the beginning of next year, mainly as major economic data continue to show signs that second derivatives are indeed turning positive, we fear that the possibility of a double dip recession is increasing.

Part of the reason for our less optimistic view of a consistent recovery is that we believe energy prices are rising at an extremely quick rate, particularly crude oil price, putting pressure on overall corporate earnings and on consumption. After bottoming at approximately $42 per barrel in mid February, crude oil has increased over 50 percent in just six months. At this rate, crude oil could be close to $100 per barrel by early next year. One of the reasons oil has been climbing at this rate, despite that the U.S. has cut back on crude consumption, is that other emerging economies, particularly China, have been ramping up consumption. Another reason is that the risk of devaluing the dollar has been increasing as the U.S. government has taken action to significantly increase liquidity in an effort to unfreeze the credit markets after the worldwide financial crisis.

Another possible cause of a double dip recession that we see comes from the massive amount of government debt. In June, the Congressional Budget Office (CBO) said this year's U.S. budget deficit is now projected to be approximately $1.8 trillion ($100 billion more than estimated in March), representing 13 percent of gross domestic product (GDP), the highest level since World War II (this estimate was 11.9 percent in March). Next year's deficit is forecasted to be nearly $1.4 trillion ($300 billion more than previously expected), representing 9.9 percent of GDP (March estimate was 7.9 percent). The CBO now estimates a 10-year deficit of $9.1 trillion under the President's policies. This is huge, and would add to the already existing debt of approximately $11.5 trillion. In order to get a better sense of how large $11.5 trillion is, we divided this figure by the U.S. population (about 300 million); this equates to just over $38,000 in debt for every man, woman, and child among us.

The expected debt level for 2010 and beyond will likely cause long term interest rates to increase in the not so distant future, stifling economic growth even before it is able to reach normal growth rates of 3%. Furthermore, there is also the risk that the Fed will monetize some of the current government debt. While it can be argued that this should help offset increasing interest rates, given the huge levels of expected borrowing, we do not believe the offset will be significant. What will certainly attenuate economic growth is the increase in liquidity resulting from the monetization of debt, which will continue to create inflation. At the moment, inflation is not a main concern since the liquidity that has been pumped into the financial system has been totally absorbed, but extended periods of low Fed funds rates combined with the monetizing of debt will surely create an inflationary environment, which may very well transform a lethargic economic recovery into another recession.

In sum, we believe GDP will continue to decline in the June quarter by approximately 3% and then by roughly 1% to 2% for the rest of 2009. We do not see a GDP trough happening this year, but we do believe that GDP growth in 2010 will finally turn positive, although at a very lethargic rate of less than 1.5%. However, we believe the probability of a double dip recession in the horizon of 2011 is increasing as the price of crude oil continues to ramp up, government debt continues to mount, and inflationary forces continue to strengthen.