Mr Clinton's gung-ho optimism was not wholly misplaced. Although much of Asia has sunk, the American economy has enjoyed another year's robust expansion in excess of 3.5 per cent, substantially faster than was expected a year ago. And thanks to the American locomotive, the world outside Asia and Japan has enjoyed a rate of growth - around 3 per cent - that compares favour-ably with the 2 per cent or so annual average this decade.
The key question is whether all this can last. For without America, one would need to look to Europe or Japan to take up the running.
As far as 1999 is concerned, the candid reply about America is "don't know". History is replete with examples of booms that continue for longer than anyone expects - or, just as unpredictably, reverse into recession.
But looking ahead over the next few years, it seems to us wholly improbable that the United States could continue to act as the world's spender of last resort. Indeed, the medium-term outlook appears exceedingly bleak.
One reason is capacity. America's long recovery from its early 1990s recession has not been built on a miracle of technological advance, but rather on a substantial reduction in unemployment. Even allowing for efficiency improvements, it is unlikely that America could sustain medium-term growth much above 2 per cent without running into bottlenecks.
But even more important than supply potential is the question of demand. In the face of a bigger budget surplus and a worsening trade performance, American demand has been kept alive by a tremendous burst of spending by households and companies well in excess of the advance in after-tax incomes. A now- unprecedented gap between private spending and income has been financed by lots of borrowing.
The impact on economic activity has been profound. In 1998, the volume of private spending probably rose by around 6 per cent, almost twice the increase in disposable income. Without this excess private spending and increased net borrowing, the economy would have stagnated.
Could this pattern of growth continue? The answer is a resounding "no". Without a fiscal boost, private spending would need to continue to rise faster than private income. The result would be a fabulous increase in indebtedness, both domestic and overseas.
In a report just published by the Research Group at Phillips & Drew, we illustrate the dimensions of the problem. To keep the economy ticking along at a 2 per cent or so rate of growth, private spending would eventually need to exceed income by an amount equivalent to over 8 per cent of the gross domestic product, double the unprecedented 1998 level. Outstanding private debt would escalate from nearly 1.7 to 2.4 times annual income and external debt would rise to over 30 per cent of GDP, thanks to a large and widening trade gap. Evidently, the present pattern of American growth cannot continue. At some stage, private sector spending will subside to a rate at best equal to, and more probably below, the growth of incomes. If it had not already done so, the stock market bubble behind much of today's spending buoyancy would burst, amplifying the deflation.
Britain's experience before and after the late 1980s boom offers a parallel. Spurred by explosive house prices and financial deregulation, Britain's private sector overspent its income at the peak by 6 per cent of GDP. Nemesis came during the next three years as a deep and brutal recession. But even if we assume in America's case a much less marked reversion in saving behaviour, we find that the shock could potentially wipe out economic growth on average over the next five years.
The collateral damage to the rest of the world would be severe, but very unevenly distributed. Worst affected would be those economies heavily reliant on exports to America - Canada, Asia and Latin America. Thanks to their much lower exposure, Europe and Japan would suffer least from a US stagnation, although a further shock to a depressed Japan hardly bears contemplation.
But surely none of this could happen? Would not economic policy respond with vigour to the potential deflation and substantially cushion the blow? Our answer is "yes" and possibly "no". Yes, interest rates would be brought down swiftly - but in the advanced world there is not that much room for manoeuvre. Nominal interest rates might have to fall to zero simply to match falling price expectations. If so, there would be no scope to offset the deflation by monetary means.
The spotlight is therefore turned on fiscal policy. Fiscal explosion would be a more promising option, but cannot be undertaken by America alone. If America merely replaced deficient private demand with extra public demand, the economy would run ever larger current account deficits. The only plausible solution would be co-ordinated fiscal pump priming in Europe and America. And how likely is that? Bill Clinton is savouring the budget surplus while European governments face institutional and intellectual hurdles enshrined in the oxymoronic Stability and Growth Pact. Yet without a radical rethink by policy makers of their fiscal aversion, the world may face a road disfigured byglitches, if not the abyss.
Bill Martin works for Phillips & Drew, and Wynne Godley works for the Jerome Levy Economics Institute.Reuse content