Stephen King: America beware - dollar could be its downfall

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The Independent Online

Last week was momentous in many ways. A 250th birthday for Mozart. Hamas victorious in the Palestinian elections. Chantelle triumphant in Big Brother. And the US economy slowing rather abruptly. Admittedly, the last of these is not likely to generate quite so much coverage as the others, but the degree to which the US economy faded in the final quarter of last year comes as a bit of a surprise. For the world economy, it's a potentially disturbing event: after all, conventional wisdom suggests that the US consumer has been the difference between sustained global expansion and catastrophic recession, so a US slowdown may carry implications that stretch well beyond America's borders.

The Americans like to express all their data at an annual rate, so the reported increase of 1.1 per cent in US GDP in the fourth quarter is the equivalent of an increase of a little shy of 0.3 per cent in, say, the UK. By US standards, this is not good enough. Most economists believe that the sustainable rate of growth in the US is around 3.0 to 3.5 per cent per year, so the fourth-quarter's performance is, frankly, disappointing. However, there appear to be a number of mitigating factors. An all-too-frequent distortion these days comes from auto sales, where discounts are imposed one quarter, only to be removed in the following quarter. Auto sales, having risen at an annualised rate of 12.7 per cent in the third quarter, fell an enormous 44.9 per cent in the fourth. Transportation equipment, another notoriously volatile component, fell 17.7 per cent in the fourth quarter following sizeable gains through mid-year.

So there are reasons to think that the slowdown may only be temporary: and these will, I suspect, be enough to persuade the Federal Reserve to carry on with its persistent tightening of monetary policy. Nevertheless, the fourth-quarter data do contain some rather disturbing features. Even though investment in computers and IT equipment more generally was buoyant, overall capital spending was soggy, notwithstanding what looks like continued rapid gains in corporate profits. Trade continued to act as a major drag on the pace of economic expansion: exports may have risen 2.4 per cent at an annual rate but this gain was tiny relative to the 9.1 per cent increase in imports.

The combination of weak investment and poor trade is not encouraging. In the late-1990s, it was possible to argue that the widening US trade deficit was no bad thing: foreigners were flocking to invest in the US, an economy that offered higher productivity and profits than others. As the world's investors poured their money into the US, so US capital spending boomed and imports of capital equipment soared. No one seemed to mind: foreign investors got good returns and the US economy grew.

It's a lot more difficult to make that argument these days. Capital spending may have picked up in recent years, but not sufficiently to absorb the large profits now being made by US companies. The US corporate sector has become a net saver. It has more money in its pockets than it knows what to do with. But if this is the case, where in the US are all the inflows of capital needed to fund the current account deficit going? If the corporate sector has no use for them, who is keeping the US economy afloat?

The answer, of course, is the US consumer - and the US government. Consumers have been living beyond their means, spending not so much because they are earning but, rather, because they are making paper gains on their assets. In the late-1990s, the story was mostly one confined to equities. When the stock market plunged in 2000 and 2001, it looked at first as though consumer spending would, like investment, head into recession. But the US consumer proved to be remarkably resilient. The government, of course, also did its bit, borrowing to fund tax cuts that kept consumers' post-tax incomes nicely supported.

But this doesn't quite paint the full picture. Why, for example, have US long-term interest rates remained persistently lower than expected in recent years? Faced with a switch from productive corporate fund-raising towards non-productive consumer borrowing, foreign investors might have demanded a higher risk premium on US assets. Yet there are few direct signs of the need for the US to pay "danger money" to its foreign creditors. And, despite the lack of investment, there are few domestic impediments to growth: productivity gains have remained robust, suggesting that US companies are still digging out efficiency gains from earlier investments.

While it's true that foreign investors have not pushed US yields any higher, US assets have not performed as well as assets elsewhere. So perhaps there is a relative demand for danger money.

Nevertheless, foreigners appear remarkably willing to own assets that may not be worth very much if it turns out that they are not put to productive use: too many 4x4s, perhaps, and not enough investments with decent returns. So why are they so willing to throw their money away? Well, perhaps they gain other advantages. A country that gets money for nothing is likely, eventually, to become a country that loses its way: like the lottery winner who becomes rich but slovenly, the US could find itself forgetting how to progress.

Far-fetched? Not necessarily. The US enjoys a position today analogous to 14th-century Spain: back then, everyone wanted gold, and thanks to its conquests in the Americas, Spain had gold aplenty. Nowadays, everyone wants dollars: the greenback is the world's reserve currency. Spain's supply of gold left it rich but lazy, inflexible and unwilling to change. Other countries - Britain and the Netherlands, the 14th-century equivalents of China and India today - took advantage. As David Landes put it in The Wealth and Poverty of Nations: "Wealth is not so good as work, nor riches as good as earnings ... Spain became poor because it had too much money. The nations that did the work learned and kept good habits, while seeking to do the job faster and better". America, be warned.

Stephen King is managing director of economics at HSBC