My Moneyfiles Column
The US economic data we are seeing this week are a very mixed bag indeed. New claims for unemployment continue to hover round the 400,000 mark, new factory orders declined by 0.8% in August , consumer confidence falls to its lowest level since the start of the Iraq war, and yet apparently we are to believe we are on the verge of an economic recovery.
Somewhere it seems there’s a problem. If this were a normal business cycle, then we should now have that long anticipated upswing waiting, just around the corner, and this, of course, is what the markets are anticipating. But although everything looks set to run it might just be worth asking why things might not be so simple this time round. Everything here is a matter of timing and perspective. Look first, for example, at industrial production. Maybe output has come back to life in the last three months, but that doesn't stop capacity utilization being still at 20 year lows. Then again, and as everyone must surely know only too well by now, there's the little problem of employment. Given the strong productivity performance and the increasing population of working age many estimates suggest that the US economy may need to grow at around 4% simply to start generating net new employment.
Since the official end of the recession in November 2001 the U.S. economy has grown at an annual rate of about 2.6 percent. That may not sound so bad, until you think about the labour market problem (and until you remember that Federal spending has gone from a 2% of GDP surplus to a 4% of GDP deficit in a very short space of time, which is one hell of a stimulus for just 2-3% growth). In fact non-farm payrolls have fallen by, on average, 50,000 per month since the "recovery" began, accounting for 1 million of the 2.7 million jobs lost since March 2001. This problem of ongoing job-loss is compounded by the fact that after heavy immigration over the last 15 years the working-age population in the US continues to grow at a fair clip. (I should strees that mid-term this is an advantage for the US as there will be more people working to pay for the baby boom pensions, but in the short term it represents a problem. As I said before, this is all about timing.) So, just to keep up with this demographic drift the U.S. needs to add about 110,000 jobs per month. Brad Delong recently estimated that the 400,000 new signings a month figure which is seen as critical is probably too high in this context. Any number over 350,000 new signings a month and the US job market continues to weaken.
And not only are the jobs being lost in manufacturing, IT and the internet enabled services sector are also taking a big hit. In fact since the peak in March 2001, employment in the information sector – which lost 16,000 workers in August alone - has declined by 459,000, or about 12 percent. At the same time employment in computer systems design, which lost 8,000 workers during August, has declined by 232,000. Meantime two areas are gaining employment. In August health care and social assistance in gained 25,000 jobs , which was about in line with its average monthly employment increase over the prior 12 months. Construction employment also went up: it has been gaining workers since February at an average of 20,000 jobs per month. Obviously the rise in construction is associated with increased housing demand which is in part produced by US demographics and in part by low interest rates, whilst the growth in health care is a product of the fact that America is an aging society. The important point is that neither of these are the important 'next big thing' area which might enable the US economy to balance it's internal employment and external commerve shortfalls.
Then all of this is compounded by the fact that the economy, when it is working, is highly productive (parodying the late Rudi Dornbusch: the US manufacturing sector isn't working too regularly, but when it is, boy is it productive). Productivity continues to rise at a rate of 5% per annum or more, and this only adds to the pressure. Really, more than any other OECD economy, the US is 'condemned to grow', and this is where we hit the snags.
As I have been trying to argue for several months now, all that outsourcing is fine - and indeed necessary for US companies to try and maintain competitivity given the height of domestic dollar-denominated labour costs - but you need value generating activities to pay for it, you need to be able to export, and to export (as the Japanese have been finding out) you need growth somewhere else. You also need a currency which is competitively valued, but it is here that we discover just how finely balanced the whole global economy actually is. The recent G7 meeting was intended to give a signal (a watershed I think was Snow’s actual expression) that the strong dollar policy is over. But what happens? The dollar begins to drop, US manufacturing begins to see export opportunities, the economy in general starts to rev up, people see growth on the horizon, equity prices start to rise, and back comes the money into the US looking for some action, with the unwelcome consequence that the dollar starts to climb, and the export opportunities start to disappear, and............
Precisely how finely strung everything is can be seen from the treasury and mortgage interconnect. The fed genuflects one way, and down comes the treasury market, in its train sending up long rates and choking the recovery, then the fed genuflects the other, and everyone gets busy buying treasuries waiting for the unconventional tools.
So now let’s look at that other main area of concern for the US economy, deflation. In order to think about deflation you need to keep in mind what we like to call the ‘output gap’. The output gap concept is a complex restatement of what is in fact a very simple idea – that there is a price impact from continuing disparities between aggregate supply and aggregate demand. Economists normally attempt to get at the notion of aggregate supply by assessing the growth of “potential” output (GDP), which could be defined broadly as the sum of labor force growth and trend productivity. In essence, the output gap is calculated as the difference between an economy’s growth potential and its actual level of aggregate activity. If the output gap were at “zero” supply and demand would (theoretically) be in balance with the economy at ‘full employment’ and the inflation rate would be stable. When demand exceeds potential - a positive output gap - inflation can be expected to accelerate. Conversely, shortfalls from potential - a negative output gap - are associated with falling inflation; they reflect excess capacity and this gives rise to a phenomenon we have recently referred to as “disinflation.” As such, recessions are generally depicted as disinflationary macro events, while recoveries are thought to be inflationary. Fed Governor Ben Bernanke in a speech back in August reckoned that given current assumptions about GDP growth and the consequent output gap, core PCE inflation might fall from around 1.2 percent currently to 0.7 percent or so by the end of 2004. That is to say, the deflation clock is ticking.
This in part explains the current US treasury concerns about the value of the dollar. One way to try to reduce deflationary pressure inside the US would be to lower the value of the dollar. But this implies that some other currency or currencies have to rise. Now whatever the ins-and-outs of the current dispute about the value of the Chinese yuan, no-one can surely be suggesting that the Chinese currency is in any position to take the entire strain for the global economy. This responsibility normally should fall on the European or the Japanese. But this is where push definitely comes to shove.
For this is where we enter the realm of what Stephen Roach likes to call the global imbalances. Basically the global economy has become a kind of monoplane flying on a single engine, one that has made in the USA clearly stamped all over it. So when the US starts to run into trouble, there is no ready replacement to hand. The reasons why this situation has arisen are, as they say, many and debateable. Among the most important I would put the changing demography of the OECD world, and the phenomenon known as ‘population aging’. If I am right in this, then it would be unrealistic to expect any miraculous transformation of the global panorama. We are going to have to get used to living in the world we have, not in the one we would like to have. This means there simply is no short term easy solution to the problem. This fact is popular neither with politicians nor with their electorates. But lack of popularity normally isn't a problem for facts, whilst facts all too often are not a special problem for politicians.
At the end of the day the US will need to try to ‘purge its excesses’. It will need to try to accommodate itself to the changing economic reality of the times. But it will need to try and do this without recourse to any easy ‘pillar’ of support. This inevitably means we are in for a bumpy ride. Bringing the dollar down to its competitive level isn't going to be easy, in particular, and this will have to be a topic for another day, due to its role as the reserve currency. Avoiding the pitfalls of protectionism and stimulating the growth of new high-value areas of activity will also need resolve and creativity. Perhaps the final irony here is that in one sense George Bush has got what he always wanted: in the search for solutions the United States can depend only on itself.
Thursday, October 02, 2003
US Economy: The Slippery Road to Recovery
My Moneyfiles Column