The US shrugged off recent blows, but a slowdown is coming
Published: 30 October 2005
The American economy continues to amaze. There is so much political flak here in Washington at the moment, with the indictment and resignation of the Vice-President’s chief of staff, Lewis Libby, and all its implications, that the political story has pushed the economic one down the news agenda. As one commentator put it, given the economic news, the President should have been doing cartwheels on the White House lawn.
Well, he certainly wasn’t doing that. But while political headlines will always out-punch economic ones, the economic story is the one that will affect the rest of us in a way that the political one won’t.
Remember what has happened to the American economy in recent months. Hurricane Katrina brought devastation and a rise in energy prices. These hit an economy already facing a sustained increase in interest rates, one that the markets expect will continue next week. Tough stuff. So how has the economy been damaged? Hardly at all – to judge by the first set of figures for the economy out on Friday. Indeed, far from slowing, it actually picked up speed in the July-September quarter to reach 3.8 per cent annual growth. So, under what circumstances will this great growth run end – and more generally, what drives economies nowadays and what brings them to a halt?
As anyone who has visited the US in recent months will testify, the spend, spend, spend culture is deeply embedded. You can see that in these latest figures. Far from weakening, domestic consumption actually rose in the third quarter, rising at nearly 4 per cent (see bar chart). Housing did well, too, down on the first half of the year but up on last autumn. Government spending? Well, you would expect that to be up, but so too is business investment. This is pretty balanced growth, driven, it is true, by consumption because that is 70 per cent of total demand, but with other sectors also rising – even exports (not shown) were up a bit too.
There was also some good news on Friday on inflation: wage growth remained very low. The annual increase is only 3 per cent, which is the lowest for more than 20 years. This will give comfort to the Fed. Alan Greenspan puts a lot of weight on the employment cost index, as this is the best overall measure of wage pressure. The headline figure for consumer price inflation is nearly 5 per cent, which is pretty shocking, but core inflation is much lower. It won’t stop the Fed raising interest rates by another quarter per cent next Tuesday, but borrowers can be comforted by the fact that further rises will be limited as long as the rise in energy prices does not feed though into more general inflation.
Now you have to be careful about all this. These are the first GDP figures for the quarter and figures do get revised. There were also some special features: car-buying boomed in the summer as manufacturers pushed smaller vehicles and slashed the prices of gas-guzzlers. Real incomes actually fell and it will be hard for consumers to keep spending more if they are not earning more.
Remember, too, that these figures are looking backwards. If you look forwards you can see some tentative signs that the housing boom is coming to an end, as Capital Economics notes in a paper last week. There has been a sharp fall in the rate of growth in new house prices, which could be a leading indicator for what might happen to house prices more generally. For what it is worth, the share price of housebuilders has recently dipped sharply, while mortgage applications have been falling for five months. As in Britain, the housing market is extraordinarily important for its role in underpinning consumption more generally.
So while it is true that the economy has shrugged off these blows so far, some sort of slow-down is going to take place. The graph, from the Bank Credit Analyst team in Montreal, shows the relationship between the Conference Board lead indicator and actual growth. It is not a perfect “fit” but insofar as the lead indicator gives a feel for longer-term economic trends it suggests a slowing in the next few months.
That must be right. For a British observer there seems to be an uncanny parallel with the UK, where the turn in the housing market preceded a wider slowdown in the economy by about a year. If that parallel holds, US growth next year will be a lot lower than it has been in 2005.
This leads to some more general points about what determines economic growth and what dents it. One-off natural disasters don’t matter much. Such blows matter hugely in human terms and no economists should ever forget that. They also matter regionally, for reconstruction can be a long and difficult process. But Hurricane Katrina in particular was about as bad a natural disaster as the US economy could reasonably expect, for quite aside from the flooding of New Orleans, it damaged the country’s largest oil production and refining facilities at a time of an oil-price spike. But now we know that a strongly growing economy can sweep by almost unaffected. Once an economy has achieved growth momentum, it takes a lot to stop it.
Several other conclusions flow from this. An obvious one is that other countries that have established a strong-growth pattern, such as Ireland, China and India, should expect their growth run to continue a while yet.
A more disturbing one is the corollary of that: if an economy is stagnating, it takes a lot to get it moving. We are seeing slightly faster growth in the eurozone this autumn, which is good. But it is hard to see it picking up by much, particularly since the markets, at least now, expect the slightly faster growth to give the European Central Bank an excuse to do what it has wanted to do for some time: nudge up interest rates.
A further conclusion is that while UK growth has slowed this year, we should be aware that it still has momentum. Those of us who expect further interest rate cuts in the UK need to acknowledge that if the incipient momentum reasserts itself, rates may not need to come down much to keep things going.
Finally, if there are further one-off blows to the world economy – and bird flu is top of the list of threats – provided general growth is strong, it will be able to grow through these troubles.
This is a fascinating case study of what affects economies and what does not.
Fiscal reform will be the true casualty of this political scandal
Yes, but what will be the economic effect of there being an undoubtedly weaker US administration for the next three years?
It is a bit early to be thinking about this, amid the political furore in Washington. The US financial markets on Friday certainly focused on the economic news of the day, not the politics. I suppose it is conceivable that international investors, particularly in Asia, will be unnerved by the news and that may next week be reflected in the foreign exchanges and in US bond prices. But we will have to wait and see. Meanwhile, it is worth charting some of the probable consequences of having an administration not able to do much.
There are two big fiscal changes that the administration has in train: the social security reforms that are now in front of Congress and a reform of the tax code, which is supposed to follow. On the first, do not expect any significant impact, nor indeed any knock-on effects for the rest of us. What one country, even the largest economy, does on social security does not have much impact on the rest of the world.
Tax, however, is more interesting. The US may not set global best practice on taxation but what it does on both corporate and personal taxes has a profound impact on world tax systems. Other countries follow the US not because they admire it but because they have to compete.
The US tax system is not only extremely complex but also remarkably unprogressive. The rich are able to exploit loopholes to limit their tax bills to much greater extent than in other developed countries. Somehow it has to be simplified and the issue is whether the administration’s idea of how to do so will carry weight. Last April the President established a bi-partisan advisory panel to suggest revenue-neutral proposals on reform, to report by next Tuesday, 1 November.
The trouble with any tax change is that some people lose out. So ahead of the panel’s report there has been plenty of noise: attacks in the papers on the way in which householders may suffer if tax breaks are limited. (In the US you get a break on mortgages on second homes, for example.) Had the President more political capital, then maybe he could have used it to push through radical changes. Now that looks less likely. So the US will scramble along with a cobbled-together tax system.
Tax simplification is one of the great global issues of the moment. Someone, somewhere around the world, will take the lead. It is still possible it may come from the US - but on balance that looks less likely now as a result of the events of Friday.
The American economy continues to amaze. There is so much political flak here in Washington at the moment, with the indictment and resignation of the Vice-President’s chief of staff, Lewis Libby, and all its implications, that the political story has pushed the economic one down the news agenda. As one commentator put it, given the economic news, the President should have been doing cartwheels on the White House lawn.
Well, he certainly wasn’t doing that. But while political headlines will always out-punch economic ones, the economic story is the one that will affect the rest of us in a way that the political one won’t.
Remember what has happened to the American economy in recent months. Hurricane Katrina brought devastation and a rise in energy prices. These hit an economy already facing a sustained increase in interest rates, one that the markets expect will continue next week. Tough stuff. So how has the economy been damaged? Hardly at all – to judge by the first set of figures for the economy out on Friday. Indeed, far from slowing, it actually picked up speed in the July-September quarter to reach 3.8 per cent annual growth. So, under what circumstances will this great growth run end – and more generally, what drives economies nowadays and what brings them to a halt?
As anyone who has visited the US in recent months will testify, the spend, spend, spend culture is deeply embedded. You can see that in these latest figures. Far from weakening, domestic consumption actually rose in the third quarter, rising at nearly 4 per cent (see bar chart). Housing did well, too, down on the first half of the year but up on last autumn. Government spending? Well, you would expect that to be up, but so too is business investment. This is pretty balanced growth, driven, it is true, by consumption because that is 70 per cent of total demand, but with other sectors also rising – even exports (not shown) were up a bit too.
There was also some good news on Friday on inflation: wage growth remained very low. The annual increase is only 3 per cent, which is the lowest for more than 20 years. This will give comfort to the Fed. Alan Greenspan puts a lot of weight on the employment cost index, as this is the best overall measure of wage pressure. The headline figure for consumer price inflation is nearly 5 per cent, which is pretty shocking, but core inflation is much lower. It won’t stop the Fed raising interest rates by another quarter per cent next Tuesday, but borrowers can be comforted by the fact that further rises will be limited as long as the rise in energy prices does not feed though into more general inflation.
Now you have to be careful about all this. These are the first GDP figures for the quarter and figures do get revised. There were also some special features: car-buying boomed in the summer as manufacturers pushed smaller vehicles and slashed the prices of gas-guzzlers. Real incomes actually fell and it will be hard for consumers to keep spending more if they are not earning more.
Remember, too, that these figures are looking backwards. If you look forwards you can see some tentative signs that the housing boom is coming to an end, as Capital Economics notes in a paper last week. There has been a sharp fall in the rate of growth in new house prices, which could be a leading indicator for what might happen to house prices more generally. For what it is worth, the share price of housebuilders has recently dipped sharply, while mortgage applications have been falling for five months. As in Britain, the housing market is extraordinarily important for its role in underpinning consumption more generally.
So while it is true that the economy has shrugged off these blows so far, some sort of slow-down is going to take place. The graph, from the Bank Credit Analyst team in Montreal, shows the relationship between the Conference Board lead indicator and actual growth. It is not a perfect “fit” but insofar as the lead indicator gives a feel for longer-term economic trends it suggests a slowing in the next few months.
That must be right. For a British observer there seems to be an uncanny parallel with the UK, where the turn in the housing market preceded a wider slowdown in the economy by about a year. If that parallel holds, US growth next year will be a lot lower than it has been in 2005.
This leads to some more general points about what determines economic growth and what dents it. One-off natural disasters don’t matter much. Such blows matter hugely in human terms and no economists should ever forget that. They also matter regionally, for reconstruction can be a long and difficult process. But Hurricane Katrina in particular was about as bad a natural disaster as the US economy could reasonably expect, for quite aside from the flooding of New Orleans, it damaged the country’s largest oil production and refining facilities at a time of an oil-price spike. But now we know that a strongly growing economy can sweep by almost unaffected. Once an economy has achieved growth momentum, it takes a lot to stop it.
Several other conclusions flow from this. An obvious one is that other countries that have established a strong-growth pattern, such as Ireland, China and India, should expect their growth run to continue a while yet.
A more disturbing one is the corollary of that: if an economy is stagnating, it takes a lot to get it moving. We are seeing slightly faster growth in the eurozone this autumn, which is good. But it is hard to see it picking up by much, particularly since the markets, at least now, expect the slightly faster growth to give the European Central Bank an excuse to do what it has wanted to do for some time: nudge up interest rates.
A further conclusion is that while UK growth has slowed this year, we should be aware that it still has momentum. Those of us who expect further interest rate cuts in the UK need to acknowledge that if the incipient momentum reasserts itself, rates may not need to come down much to keep things going.
Finally, if there are further one-off blows to the world economy – and bird flu is top of the list of threats – provided general growth is strong, it will be able to grow through these troubles.
This is a fascinating case study of what affects economies and what does not.
Fiscal reform will be the true casualty of this political scandal
Yes, but what will be the economic effect of there being an undoubtedly weaker US administration for the next three years?
It is a bit early to be thinking about this, amid the political furore in Washington. The US financial markets on Friday certainly focused on the economic news of the day, not the politics. I suppose it is conceivable that international investors, particularly in Asia, will be unnerved by the news and that may next week be reflected in the foreign exchanges and in US bond prices. But we will have to wait and see. Meanwhile, it is worth charting some of the probable consequences of having an administration not able to do much.
There are two big fiscal changes that the administration has in train: the social security reforms that are now in front of Congress and a reform of the tax code, which is supposed to follow. On the first, do not expect any significant impact, nor indeed any knock-on effects for the rest of us. What one country, even the largest economy, does on social security does not have much impact on the rest of the world.
Tax, however, is more interesting. The US may not set global best practice on taxation but what it does on both corporate and personal taxes has a profound impact on world tax systems. Other countries follow the US not because they admire it but because they have to compete.
The US tax system is not only extremely complex but also remarkably unprogressive. The rich are able to exploit loopholes to limit their tax bills to much greater extent than in other developed countries. Somehow it has to be simplified and the issue is whether the administration’s idea of how to do so will carry weight. Last April the President established a bi-partisan advisory panel to suggest revenue-neutral proposals on reform, to report by next Tuesday, 1 November.
The trouble with any tax change is that some people lose out. So ahead of the panel’s report there has been plenty of noise: attacks in the papers on the way in which householders may suffer if tax breaks are limited. (In the US you get a break on mortgages on second homes, for example.) Had the President more political capital, then maybe he could have used it to push through radical changes. Now that looks less likely. So the US will scramble along with a cobbled-together tax system.
Tax simplification is one of the great global issues of the moment. Someone, somewhere around the world, will take the lead. It is still possible it may come from the US - but on balance that looks less likely now as a result of the events of Friday.