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Friday, March 14, 2003

Is the Bubble Finally Purged

For the Economist at least, it seems that it isn't. Far from it, and once the war issue is resolved there will still be plenty to think about. Including having a US centric global economy in which the US itself is light on saving, and where the US consumer lives thanks to a continuing inflow of foreign funds to pay the deficit and from the rising value of their homes.

To a large extent the fate of the rich economies rests on America. Stephen Roach, chief economist at Morgan Stanley, reckons that America accounted for two-thirds of total global growth since 1995. If the American economy now stumbles again, neither Europe nor Japan look ready to take over as an engine of growth. The biggest is that the economic excesses created by the greatest financial bubble in history have still not been fully purged. Ed McKelvey, an economist at Goldman Sachs, argues that the main reason why private-sector spending is weak is that households and companies are still trying to correct the huge deficits that they ran up during the stockmarket bubble.

America's private sector was a net saver for 40 years until 1997: the total income of households and firms always exceeded their spending, with average net saving of 2.6% of GDP. But the irrational exuberance of the late 1990s encouraged a massive boom in spending and borrowing, pushing the private sector into a deficit of 5.2% of GDP by 2000. In the year to the third quarter (the latest period for which data are available), the private sector was still in deficit, to the tune of 1.4% of GDP. In other words, says Mr McKelvey, the private sector is only halfway back to its long-term average rate of net saving of 2.6% of GDP.

Firms have done much to cut costs and restore the health of their balance sheets, but they have further to go. In the early stages of a recovery, the corporate sector usually runs a small financial surplus, investing less than cashflow. But America's companies continue to run a deficit. Worse still, profits have remained feeble. Ian Harwood, chief economist of Dresdner Kleinwort Wasserstein, estimates that profits across the whole economy, as measured in the national accounts, fell again in the fourth quarter of last year—the third quarter in a row of decline after a brief recovery. This may explain why firms are still cutting jobs.

American households have done even less to repair their balance sheets. Personal savings rose from 2% of disposable income in 2000 to 4% in the fourth quarter of 2002. But Mr McKelvey reckons that the appropriate saving rate, given the decline in households' total net worth as share prices have fallen, is somewhere in the 6-10% range. The main reason why households have been able to postpone their adjustment is their ability to borrow—and so spend—against the rising value of their homes. But that extra cash could soon run out: even if property prices stay high and mortgage rates stay low, the scope for home-equity withdrawal will decline. Households will then have to tighten their belts. This, in turn, implies that America's growth rate could remain below potential for some time, regardless of what happens in Iraq.
Source: The Economist

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