Despite all the worried talk about the sliding dollar, both the financial markets and economic forecasters are taking it in stride. Conspicuously, nobody speaks of a dollar crisis at present or in the future. High-riding expectations of a strong year-end rally in the stock markets have been somewhat disappointed. Yet there have been two pleasant major surprises. One is the sharp fall of oil prices, and the other is the resilience of the U.S. bond market, defying not only the dollar's weakness, but also the four rate hikes by the Federal Reserve.
It appears to be a common view that economic growth in the eurozone and Japan is badly faltering again, with both countries flirting with new recessions. In contrast, the forecasts for the U.S. economy remain rather upbeat, hailing the plunges in oil prices and the dollar.
We stick to our diametrically opposite view that the U.S. economy is prone to sharply slower growth. It is the profligate consumer who has kept the economy afloat since 2000. What kept the consumer afloat is also no secret. It was mainly two events: First, inordinate tax cuts; and second, exploding ultra-cheap borrowing facilities, made available through the Fed's creative bubble strategy and implemented by ultra-low short-term interest rates.
Together, the two have unquestionably contained the fallout from the bursting stock market bubble. They also had respectable effects in terms of U.S. real GDP growth during the second half of 2003 and the first half of 2004. Yet the most important aim of all the monetary and fiscal stimulus - to set in motion a self-sustaining economic recovery - has been flatly missed.
A "self-sustaining" U.S. economic recovery urgently needs accelerating employment and income growth. Just the opposite is happening. During the six months up to last November, real disposable personal income grew just 1%, or 2% annualized. This is down from 3% in the first half of 2004 and 4.8% in the second half of 2003. Taxes and higher inflation rates are taking their toll. Debt-financed spending went to new records. During the third quarter, private households increased their spending by $139.4 billion, while their earnings increased only $81.6 billion.
Employment and income growth are the key fundamentals of household finance. According to the reports of the Bureau of Labor Statistics (BLS), they have significantly improved in 2004. But no less than two-thirds of these gains owe their creation to the ominous "net birth/death" computer model of the BLS, designed to estimate employment growth by new business formations.
All that is needed to activate this job creation is a unilateral decision by the BLS that the U.S. economy is in a recovery. Implicitly, the Bureau of Economic Analysis translates these computer-generated additions to employment into corresponding additions to wages and salaries. Considering the persistent, unusual weakness in employment, as documented by the actual surveys, it requires a lot of heroism to assume an employment boom from new business formations.
For November, the BLS reported 112,000 new jobs, as against an expected 200,000. As bad as the report appeared, the reality was even worse. No less than 54,000 of the new jobs had come from the net birth/death computer model, compared to 30,000 jobs in November last year.
In the third quarter of 2004, consumer spending accounted for 89.2% of real GDP. It is the familiar ruinous growth pattern. A viable economic recovery would require a strong contribution through sharply higher business investment and hiring. Both remain missing, although the recovery is entering its fourth year.
Euroland's Secret Success Story:
"The United States is richer and grows faster than euroland because productivity levels are higher and productivity growth stronger - right? Actually, no. Euroland's inferior GDP performance is attributable to a slower- growing labor force that works shorter hours.
"Euroland's underlying economic performance is better than many commentators portray. Over the past decade, GDP per head has risen virtually at the same rate in euroland as the United States; euroland productivity growth (output per hour) and the rise in the employment rates were slightly faster than in the United States; and to maintain the same growth in GDP per head, U.S. workers have had to work much longer hours than their euroland counterparts."
This subtitle and the above two paragraphs are not ours. They are the introductory remarks to a study about the eurozone economy, written by Kevin Daly and published by Goldman Sachs in January 2004.
Gloomy reports about the eurozone economy always abound. To quote a leading article that appeared in The Financial Times under the headline Two Broken Motors: "The latest economic data leave the eurozone and Japan looking more than ever like two enfeebled old men unable to progress at more than a stagger."
With utter amazement, at the same time, we keep reading that the U.S. expansion remains firmly on track, particularly with sharply improving jobs data. Third-quarter real GDP growth was revised upward to 4% at annual rate, compared with an annualized growth rate of 1.2% for the eurozone. Since the end of 2000, America's output, as measured by real GDP, has grown more than twice as fast as the euro areas.
Quoting the London Economist: "Euro-pessimists see this as further evidence that arthritic economies are being held back by lazy workers and by governments unwilling or unable to carry out reforms. In contrast, America's more robust recovery, it is often said, reflects its amazing flexibility."
Our view, in contrast, is that the U.S. economy's recovery since 2001 peaked in the first quarter of 2004. This assumption is primarily based on four observations: First, it is the overwhelming message of recent economic data and early indicators; second, the power of egregious fiscal and monetary stimulus has been spent; third, continuous rate hikes by the Fed will prick both the carry trade and the housing bubbles; and fourth, the U.S. economic recovery is of a flatly unsustainable pattern.
To prevent a more painful fallout from the bursting equity bubble in 2000-01, Fed Chairman Alan Greenspan systematically blew three intertwined new credit bubbles: the carry trade bubble in bonds, house price inflation and the mortgage refinancing bubble.
It was the policy of a desperado who did not care at all about adverse consequences in the longer run. In actual fact, the very imbalances that provoked the preceding recession have grossly worsened under the impact of the new asset and credit bubbles.