Stephen King: World economy's eggs all in US consumers' basket

Click to follow
The Independent Online

During this latest global recovery - the one that started following the Federal Reserve's emergency interest rate cuts, in turn a response to the deflationary fears associated with the stock market crash - the world economy has increasingly placed its eggs in only one basket. That basket - or, perhaps, more aptly, that shopping trolley - is in the hands of the US consumer. Consider the facts:

* In 2004, US consumers accounted for more than half of all of the increase in consumer spending recorded globally, even though the US economy accounts for a little less than 30 per cent of global economic activity.

* The rise in current account surpluses in many parts of the world - whether it be the surpluses of oil-producing nations (Opec, Russia) or major manufacturing nations (China) - has, as its corollary, a rise in the US current account deficit. If there's a savings glut in the surplus nations - as Ben Bernanke, the Chairman of the US President's Council of Economic Advisers would have us believe - its recessionary effects are only being absolved through excessive US consumer borrowing.

* Within the US economy, companies have maintained their cautious post-bubble spending, for the most part preferring to save: the recovery in demand in recent years owes a lot more to the consumer, fuelled by gains in the housing market. The household saving rate has recently moved into negative territory, a sure sign that the world economy is increasingly dependent on an overly-mortgaged US consumer.

So if evidence starts to mount that the US consumer might be in a little bit of trouble, as Ian Morris, HSBC's New York-based economist is currently suggesting, we all need to sit up and take note. A US consumer slowdown won't just hit the US economy: it will also have a nasty impact on the world more generally.

The biggest single risk to US consumer spending lies with the growth rate of US household incomes. For many years, US household incomes have grown relatively strongly, helped by the productivity miracle that seemed to suggest that the US could have its cake today, eat it today, and then have an even bigger cake tomorrow. More recently, though, productivity growth has slowed and, perhaps more importantly, labour has failed to maintain its share of the rewards that stem from productivity improvements.

For the purposes of economic analysis, household incomes need to be measured in real terms, in other words adjusted for the effects of inflation. Over the past twelve months, inflation has risen rapidly, driven up for the most part by higher oil prices. On the latest reading, for September, the annual rate of consumer price inflation had risen to 4.7 per cent. But because wages and other sources of household income have been unable to keep pace, there's a good chance that, when the data is published, we'll find that household real incomes will have contracted in the third quarter. Indeed, unless energy prices suddenly come down a long way, it's likely that real incomes will also have contracted in the fourth quarter as well.

A second area of concern is the stock market. On this side of the Atlantic, we've enjoyed a rather pleasant rise in stock prices for much of the past year or so. Over the other side, the story has been rather different. In real terms, adjusted for inflation, stock prices are down compared with the beginning of the year.

Admittedly, the US has had to cope with shocks not seen elsewhere in the developed world - notably Hurricane Katrina - but I suspect that something more fundamental is going on. Whether it's stocks or bonds, US assets have underperformed those elsewhere in the world. Investors may still be happy to buy the dollar - after all, the Fed keeps jacking up short-term interest rates - but the appetite for riskier US assets seems to have fallen away over recent months. In other words, the stock market gains of old - the rocket fuel that kept the US economy expanding rapidly in the 1990s - are no longer driving consumer spending.

To date, the housing market has kept the US consumer's head above water. How much longer this story can carry on for is, however, somewhat debatable. Here, I merely have to quote Alan Greenspan, in his closing remarks at the Jackson Hole central bank symposium in August: "Nearer term, the housing boom will inevitably simmer down. As part of that process, house turnover will decline from currently historic levels, while home price increases will slow and prices could even decrease ... an end to the housing boom could induce a significant rise in the personal saving rate, a decline in imports, and a corresponding improvement in the current account deficit. Whether those adjustments are wrenching will depend ... on the degree of economic flexibility that we and our trading partners maintain, and I hope enhance, in the years ahead."

Time, therefore, seems to be running out for US consumers: not enough income gains, not enough stock market gains and, in the future, not enough real estate gains. So why are households still spending? I suspect part of the answer lies in the difference between expectations and (subsequent) reality. It makes sense for consumers to borrow to fund current spending if, for example, they believe that oil and gasoline prices will come back down again. So long as people link higher oil prices to "temporary" phenomena - such as Iraq and Katrina - they might believe that the hit to their incomes is only temporary. It also makes sense for consumers to borrow if, unlike Alan Greenspan, they simply extrapolate recent house price gains into the future.

I doubt, though, that this process of "suspended disbelief" will be forever maintained. US households are facing two threats. First, the Federal Reserve is not only raising interest rates at a rate of knots but also, increasingly, linking this tightening of monetary policy to overheating in the housing market. The Bank of England used a similar approach with some success last year.

Second, the rise in energy prices is not a temporary phenomenon. A reflection of China's and India's emergence on the world economic stage, it's a sign of a major shift in the constellations of economic spending power around the world.

Simply put, the collapse in telecommunications charges and the transformation of the world political order following the disintegration of the Berlin Wall have dramatically increased the supply of labour available to western capital. By doing so, western labour's relative price has fallen compared with the other factors of production, namely capital, raw materials and developing market labour.

So far, this hasn't had much of an impact on the US, where house price gains have masked this underlying loss of household spending power. But the time will come when the housing market does "simmer down" and, when this happens, we'll discover the true underlying resilience of the US consumer and, indeed, of the world economy. The US consumer's shopping trolley may, in the past, have been easy to control but we all know that shopping trolleys have a nasty habit of heading off in entirely the wrong direction.

The roulette wheel is spinning and the croupier is puzzled. "All bets on one number? How bizarre."

Stephen King is managing director of economics at HSBC