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(February-2004) Excuse US while we grow stronger
Who can forget the extravagant claims of the dot com boom (or more accurately, the dot.con boom)? In the hysteria of the time, traditional methods of valuing companies were discarded and companies that had never earned any revenue, let alone profit, were valued in the billions. Any Doubting Thomas was told that a “new paradigm” applied.
In the event, the new paradigm turned out to be an old fashioned market bubble and, nearly four years on, the Nasdaq is languishing some 58 per cent below its peak of March 2000. But with the dust now settling on one of the market’s wildest roller coaster rides ever, the irony is that productivity growth is faster in the chaotic noughties than it was in the fabulous 90s. Much faster, in fact, at an average of 4.7 per cent a year so far in the new decade, compared with 2.7 per cent a year on average in the 90s.
Productivity generally picks up when the economy comes out of recession and there is now no doubt that the US economy has left the 2001 recession in its wake. Even allowing for cyclical impetus, US productivity growth is surprisingly strong. Was there some substance after all, to the tech led boom of the 90s, even if the market overdid it just a tad?
Much hangs on the answer to that question. Depending on how you measure it, the US accounts for between a fifth and a third of the world economy and over half of world equity market capitalisation. In the second half of the 90s, while Europe settled for second best and Japan struggled, the US accounted for a staggering 40 per cent of world economic growth.
In the short term there is good cause to think US dominance of the world economy will continue. With short term interest rates at around one per cent, and Uncle Sam doing his bit with tax cuts and government spending, the US consumer is super confident and spending like crazy and housing is enjoying an expansion that seems like it will never end. The stock market has picked up from its lows and business is starting to invest again. Even if US employers are proving stubbornly reluctant to make new hires, employment is generally a lagging indicator. It seems likely that in 2004 the US is headed for growth of 4 per cent plus.
Sounds too good to be true? You’re right. The catch is that in the process of growing faster than the rest of the world and pulling itself out of the 2001 recession through aggressive policy stimulus, the US has built up some debts. Some debts! The rest of the world must invest $1.6 billion per business day in order to fund the US deficit on its current account. While scary, that is a fairly meaningless statistic. In any case, if the rest of the world regards the US as a good place to invest, then why worry?
There are two aspects of the US current account deficit that are cause for concern — the dynamics and the quality of the deficit.
On the dynamics: the US current account deficit has reached the point relative to the size of the US economy (it’s now 4.8 per cent of GDP), where it becomes more and more difficult to hold it stable. Imports now exceed exports by such a margin, that ABN Amro has calculated that, if import growth were 5 per cent over the next three years, export growth would need to be 10 per cent just to hold the current account deficit at its present proportion of GDP.
One way out is for the US dollar to depreciate, but this makes it harder for Europe and Japan to grow. The quickest form of adjustment is to slow import growth by slowing the economy. However, recessions that we had to have don’t go down so well with the punters.
On the quality of the deficit: the US budget has turned from surplus to deficit and there is every prospect that the Federal Government’s books will remain in the red. In his 2004 State of the Union message President George W Bush pledged simply to halve the budget deficit. And that’s a pledge. But even halving the budget deficit would require tough political decisions.
The greater the size of budget deficits and the longer they accumulate, the more uneasy foreigners will become about investing in the US. When their capital is being used to fund productive investments by US business, foreigners can see they are contributing to the productive capacity of the US economy and the more confident they can be that they will be repaid their loans or receive dividends on their investments. When they are given IOUs from the US government and those IOUs mount up, then they will require higher rates of interest to be willing to loan their hard earned Euros or yen or yuan.
So why does it matter if the New Economy was a chimera or an emerging reality? Productivity growth has the potential to be the circuit breaker. High productivity growth makes the US economy more competitive. It generates wealth and helps keep inflation in check. It also makes foreigners more willing to invest in the US.
It is most likely that the US will continue to grow strongly in 2004, but it is going to have to adjust to the external and budget imbalances that have developed. The greater its productivity growth, the less painful the adjustments.
— Dr David Chessell is a Director of Access Economics
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