Can The US Record Another Decade of Uninterrupted Growth?
Publish Date : 17/07/2007Author : Marc Hendriks
Email : marc.hendriks@thomasmiller.com
Can The US Record Another Decade of Uninterrupted Growth?
The buoyancy of stock markets around the world suggests a global economy that is functioning well. In terms of economic growth this is true. The United States experienced a decade of uninterrupted economic in the 1990s and, with the briefest of interludes, has almost completed another six years of continuous growth. During the past six years economic growth outside the United States has been an even stronger picture due in large part to structural change in China but also in Japan and more recently Europe.
This pattern of economic growth seems set to continue for the remainder of this year and next. This assumption is validated by the interest rate futures markets. Having begun the year assuming that interest rates in the United States would be cut this year by at least 50 basis points, the markets are now suggesting no change in interest rates through to the end of 2008. In Europe and Japan interest rates are expected to maintain a steady upward path.
Does this mean that the US economy is likely to experience another decade long period of economic growth as in the 1990s? A brief summary of the risks to growth will help to answer this question.
Risks to Growth
The most discussed risk is that the current downturn in the US housing market leads to a collapse in consumer spending which is sufficiently large to lead to a contraction in the overall economy. This has been much heralded as the trigger for an easing in US monetary policy but so far this is the dog that didn’t bark. Fortunately for the US the tightness of the labour market has been an offsetting factor by supporting income growth. In addition the strength of the global economy has also offset the weakness of the housing market. This is a good time for the US to have a housing crisis!
Another potential source of economic weakness is a financial crisis in the US, such as recent crisis in the sub-prime market. A full blown financial crisis is always a possibility but a rather remote one. The estimated $52bn of losses on sub-prime debt is a large number but small relative to the total size of the US financial markets so there is certainly no issue of insolvency. Liquidity crises seem to be contained within the afflicted area. The Federal Reserve and private financial institutions have provided assistance, without offering a general bailout as in the recent case of Bear Sterns. While there are aspects of the financial system’s recent developments that cause concern because of the lack of data and supervision, it only those that believe in the merits of the gold standard that attribute a high probability of a financial crisis in the near term.
The rapid growth of the Chinese economy has been a significant factor behind the remarkable growth of the global economy in recent years. A reversal in China’s fortunes would have ramifications for the US economy. It is now a case that if China sneezes the rest of the world catches a cold. Difficult as it is to judge the economic, financial and political risks in China, there are no weaknesses in the Chinese economy that cannot be addressed by the authorities given they control so much of economy.
A sharp decline in the value of the US dollar is often cited as a possible Achilles Heel of the US economy. Weakness in the US dollar would require a sharp increase in US interest rates to attract sufficient capital to finance the US current account deficit. Today the trade weighted – index of the US dollar is near a twenty year low. The adjustment is happening without any drama. The fear of foreign investors dumping US assets is always present but is more academic than practical. Especially as many of the US dollars are now held by foreign governments who have no interest in destroying the value of their assets!
Political developments are always a source of concern. There is little room for optimism given the lack of international coordination on any of the major issues such as the Middle East, the sharing of vital energy sources and global warming. The political changes in Europe over the past year have not made any progress to a more politically forceful Europe. Indeed, it is probably relatively weaker given the oil- strengthened hand of Russia. This is demonstrated by the lack of a European unified response to Russia over the murder of Litvinenko in London. Maybe the US Presidential elections will change the scene but that is still two years away.
Energy and Inflation are the biggest risks
With the exception of political factors, none of the above risks have a high probability of de-railing the US economy. There are two risks, however, that have a much higher risks of curtailing US economic growth. The first is the price of energy. Crude oil prices are approaching the level of the 1973 oil price shock of $100 in constant dollars. This of itself is not a reason to be alarmed. The global economy has easily absorbed the price rises to date. However, further rises cannot be ruled-out because the rise in prices today has occurred for a very different reason to that of 1973. The prices rises today reflect the realisation that energy supplies are diminishing and there are no viable alternative appearing in the foreseeable future. For as long as the global economy expands, energy prices will rise because demand will outstrip supply by ever increasing margins. The only known antidote to rising energy prices is recession.
The second significant risk is inflation. The global economy is red-hot. The days of constantly falling manufacturing prices offsetting service sector inflation are rapidly passing. The most likely factor which will prevent another decade of uninterrupted economic growth will be the Federal Reserve having to raise interest rates, along with other Central Banks, to fight that old enemy – inflation.
