Hamish McRae: It's not just a tricky economy that the next US president will have to navigate

Economic view
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The Independent Online

So what economy will the next American president inherit and how might he tackle the overriding concern of many, maybe most, Americans that they are seeing very little rise in their standard of living and may now experience a drop in it? There is a cyclical problem and a structural one. Take the cyclical first.

During George Bush's first presidential campaign in 2000 he asked his economic adviser, Lawrence Lindsey, about the prospects for the next four years. Dr Lindsey explained that the economy was facing a recession triggered by the collapsing internet bubble, and went into detail about the other problems that would most likely strike it.

"You know, Larry," said Bush, "if you're right, I'm not sure I want this job."

There was indeed a sharp downturn, though thanks largely to Alan Greenspan driving interest rates down below the level of inflation it turned out to be a less serious dip than in the early 1990s or early 1980s. But that easy-money policy laid the foundations of the next bubble – house prices – that may well turn out to have much more serious consequences. A new president will take over in much the same cyclical position, though this time we are a bit further down the line, but in a worse structural mess thanks to the scale of the excesses and their global fall-out.

It is not a great inheritance but how bad is it likely to become? Are we really talking a re-run of the 1929 crash and the 1930s depression?

As a frame of reference, consider some new forecasts for the G7 economies through next year. They come from ING Bank and I have chosen them because the team there has a good reputation and, at a time like this, private-sector forecasts are swifter at picking up any deterioration in the outlook than the various official forecasts. The prospect is for the US economy (Graph 1) to shrink next year by a little less than 1 per cent. That's the same as Japan, with the UK having the worst outlook at minus 1.7 per cent. Last week we had confirmation that the US economy shrank in the July-September quarter, largely because of a slump in consumption. What seems to have happened is that consumers kept spending right through until August before panicking and starting to pull back. It seems unlikely that they will recover their confidence until there is some sign of US house prices bottoming, so that outlook of the US economy shrinking next year looks pretty much on the button. (If those numbers prove anything like right, then we in the UK will experience an even nastier recession.)

So there is a great deal of alarmist stuff of this being the worst recession since the 1930s and so on. I think this is wrong, but you have to accept it is a possibility. It may be that the next president will have to cope with a real cracker of a recession. So how does this cycle compare with the early 1930s?

If you look simply at the stock market, there would still be a long way to go down. Graph 2, from the team at Commerzbank, shows what happens if you plot the Dow from its most recent peak beside what happened in the 1930s. As you can see, were things to follow that path it would be 2011 before it bottomed out, which would be scary indeed.

There are, mercifully, massive differences between the situations now and then. Commerzbank notes five. One, central banks are no longer stuck on the gold standard and can expand money supply, as they have done (Graph 3). Two, governments are supporting the commercial banks instead of letting them go. Three, fiscal policy is being actively used to boost the economies, instead of governments trying to balance budgets. Four, there are automatic stabilisers in action: for example, social security has been greatly expanded. And five, governments are co-operating internationally.

You could add that present stresses follow a period of great prosperity rather than the wrenching loss of wealth, as well as life, from the First World War. Still, it will be a testing ground for the new administration and it won't have had any time to bed down. Americans, like Britons, are not good at forgiving politicians who damage their prosperity and it is possible that this next presidency will catch the blame for what was really his poisoned inheritance. If the normal economic cycle reasserts itself, there should be solid growth long before 2012 and I think that this is by far the most likely outcome. In the 1930s, the core of the problem was not the stock- market crash but the appalling policy response to it. That undermined the self-healing qualities of market economies, with dreadful consequences. After a slow start, global governments are now on the case. Nevertheless the new president will have a subtle message to get across to the electorate. Part of this will be to convey confidence, that world governments and central banks do have the competence to hold things together. But equally, he will have to explain that US citizens must make major changes. For example, the share of GDP that goes into consumption, at 70 per cent the highest in the world, will have to come down. And this is part of the structural problem that the next president has to tackle.

Reducing the share of consumption will be difficult because the US middle class has had little overall increase in its living standards over the past two decades. True, living standards were very high then, so stagnation has been on a high plateau. Most people in most countries would love to have US living standards. But for most Americans, the excesses of high earners come at a time when they feel themselves squeezed. One obvious response to this would be for the state to try to redistribute the wealth rather more effectively than it has to date and many of us on this side of the Atlantic would see that as an obvious policy objective. The problem is, the numbers don't work well.

Sure, pay differentials have shot up and it is not clear quite why that has happened. But the absolute number of very high earners is still small, and there are not enough of them to provide the resources to lift the mass of the population much. Redistribution can help, but there is a bigger issue. This is that parts of the US economy are not too efficient. The country spends double the proportion of GDP of most European countries on healthcare for outcomes that are little better and in some cases worse. Legal fees redistribute wealth in a random way without increasing it. The US uses one-and-a-half times as much energy as most European nations, without significant benefits.

This is such a huge subject that it is impossible to do justice to it here. My point is simply that the US economy, for all its strengths, has structural problems that will have to be tackled over the next half century – and that a wise new president has to try to make a start on these, as well as helping manage the country through an undoubtedly tricky economic cycle.

Why is Barclays looking east? Reason No 5 – that's where the spare cash is

A puzzle. Why should Barclays prefer to have the governments of Abu Dhabi and Qatar as shareholders rather than the government of the UK? Indeed, for banks needing capital, getting it from the British government has become a last resort, something you only do if you cannot get it from anywhere else.

The answer comes in at least five levels. First, there is the narrow one that the UK government seems to have stipulated that banks that borrow from it cannot pay a dividend to their other shareholders until the government capital is paid back.

This was apparently a European Commission requirement. It is particularly stupid because it shuts down the possibility of getting much money from other shareholders. Why should they invest when there is no early prospect of getting any return? Foreign capital does not carry this penalty with it.

Second, the UK government will insist on having a say on bank policy. In principle, that is quite right, for if taxpayers are risking money they should be represented. But if this means that banks are going to be forced, or at least encouraged, to lend to more risky customers, then that is probably bad business. It will further hobble the banks and make them less competitive internationally. Foreign capital, by contrast, will want to see the bank run competitively.

Third, foreign governments are in for the long haul. They don't want their capital back at the first opportunity. The UK government, by contrast, is short-term in its aims – just the sort of attitude it would criticise in City investors.

Fourth, foreign governments are willing investors, wanting a stake in a British bank because they think they will make money out of it. The British government is a reluctant investor, only putting money in because it has to in order to save the bank.

And the fifth? Very simple: foreign governments have spare cash; ours doesn't.

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