RSS feedsThe broad outline of events is very familiar. A previously robust economy is slowing sharply, the housing market is in freefall, unemployment is rising, consumer confidence is evaporating, government finances are fragile and corporate profitability is under pressure. If that is not enough, there’s the credit crunch and systemic weakness in the financial sector all conspiring to create the perfect storm.
Yet not everyone is convinced the outlook is unambiguously bleak. GDP for Q2 was surprisingly strong, the currency has been strengthening and business opinion surveys suggest the low point has been passed. However, opinion on where the US economy goes from here is divided.
What happens to the US matters greatly to the UK, for several reasons. Not only is the US still our single largest export market, but the substantial profits and dividends earned by British companies on their American investments have made a substantial contribution to our balance of payments. Both depend on a buoyant US economy. And, since the two major Anglo-Saxon economies have had much in common in recent years more so than the UK has had with Europe the extent and length of the slowdown across the Atlantic may have some lessons for UK policymakers.
Events in the US have been running a little ahead of the UK, but there, as here, it has been the personal sector that led the economy up and is now taking it down. Having loosened policy after the dot.com bust and 9/11, by cutting interest rates to 1% and reducing taxes by 5% of GDP, the Bush administration ensured that annual growth from 2003-06 averaged 3%, much of it based on consumer spending and the housing market.
As inflation began to edge up, the policy was reversed and interest rates rose 17 times, in all to 5.25%. Not surprisingly, the heavily indebted consumer retrenched and the housing market nose-dived, taking with it several heavyweight financial institutions, including Fannie Mae and Freddie Mac.
For much of 2008, analysts have predicted a technical recession in the US, but the inconvenient truth of the data kept spoiling the argument. The annual rate of GDP growth in Q1 was just 0.9%, but in Q2 it bounced back with a robust 3.3%. Most of this (3.1%) was down to international trade, a surge in exports and a drop in imports. The increase in domestic demand was just 0.4%, despite the huge tax cuts. This ‘rebalancing’, helped of course by a weak dollar, is exactly the sort of adjustment the Monetary Policy Committee wants to see in the UK.
Even though the Fed said in June that “the downside risks to growth have diminished somewhat”, pessimism still prevails about short-term prospects. Stateside unemployment has risen by 2.2 million in 12 months (to 9.4 million or 6.1% of the labour force in August), consumer price inflation is a concern (it had climbed to 5.6% in the year to July), while personal disposable incomes fell in June and July. And, of course, the recent strengthening of the dollar will make it difficult to sustain the recent export growth, particularly when much of the rest of the world is slowing.
It is easy on the UK side of the Atlantic to underestimate the flexibility, robustness and resourcefulness of the US economy. Moreover, growth traditionally picks up in presidential election years and this could yet boost confidence, whatever the outcome.
But the balance of the argument still seems to favour the pessimists. Although a recession will probably be avoided, the US is likely to have sub-2% growth this year and next.
All the usual numbers point to a classic ‘on-the-one-hand… but-on-the-other’ argument. But this time, the usual numbers have to be over-ridden largely because this is not just another swing of the cycle. On top of the domestic spending squeeze, the US is grappling with the biggest housing market collapse for a generation, and associated banking sector problems.
The rate of decline in the influential S&P/Case-Schiller (house price) index might only now be starting to slow, but the cumulative fall in house prices has exceeded the 30% recorded in the 1930s Depression. Factor in the huge problems to the banking system caused by reckless mortgage lending, and it is clear that this is not just another downturn.
Much of what has happened in the US is echoed in the UK, not least the squeeze on consumers, the stalling of the housing market and the credit crunch. Where the US has been different, and why it should avoid a recession, is the speedy response of its policymakers. When the problems emerged, interest rates were cut, and cut aggressively.
The authorities took the view that growth and jobs were a higher priority than inflation and, from 5.25%, the Fed reduced rates to just 2% in seven months. Now that oil prices seem to be falling, there is an expectation that the MPC (belatedly) will take a leaf out of the Fed’s book, which is why a Bank Rate of 4% by end-2009 (and even less according to some forecasters) is now on the radar.
