Worse in the US doesn't mean bad

The big message is that after the gallop the economy will slow to a 3 per cent canter
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The Independent Online

Could this turn out to be the election you want to lose? While the US political process remains locked at both the presidential and congressional levels, this quiet question is forming itself in the more astute political minds of both parties. Why? Because of the lack of mandate of the new president, sure, but also because of the "R" word, recession.

Could this turn out to be the election you want to lose? While the US political process remains locked at both the presidential and congressional levels, this quiet question is forming itself in the more astute political minds of both parties. Why? Because of the lack of mandate of the new president, sure, but also because of the "R" word, recession.

To be clear: the balance of probability is still that the US will avoid recession in the next couple of years but conversely if there is a less-than-even chance of recession, there is a dead certainty of a slowdown. That slowdown has already begun. The issue is how the US manages the move from a heady 5-6 per cent growth to a sustainable 3 per cent one. In the preferred jargon of the markets, does the American economy have a hard landing or a soft one?

For what it is worth, the balance of opinion in the various banks and other private sector forecasting agencies seems to be that there is about a 30 per cent chance of the hard landing: a recession or a period of such slow growth that it feels like one. The graph on the left shows the 70 per cent mainstream alternative with estimates from the New York bank JP Morgan and the consensus. There are differences of tone between the two for the bank is a bit below the consensus, but the big message is that after the gallop of the last couple of years the economy will slow to a steady 3-ish per cent canter.

If that proves right, then all worries are off. Well, not quite. First, growth has rarely followed quite such a steady path as that, so expect a slightly less smooth profile, even if the numbers at the end of the year turn out to be close to the 3 per cent. Second, Americans have experienced growth of more than 4 per cent for a long time, so that slower growth might feel to them like a recession, even if it isn't.

As evidence of this last point, note how US companies such as Dell that promise only 20 per cent growth (instead of 30 or 50 per cent growth) get their share price hammered. The boom has created unrealistic expectations for company performance - that we know. Has it also created unrealistic expectations for the performance of the economy in general, for jobs and wages?

Much has been made of the extent to which US households have been "dis-saving" - relying on the rising value of their shareholdings to compensate for spending more than their income. Certainly the ratio of wealth to income soared over the last five years, and it is true too that the ratio has come back a bit this year as shares have stagnated.

But there are only tiny signs of any slowdown in the shops and the jobs market has remained very strong. So far, at least, there is little to suggest that lacklustre markets have hit consumption.

But what about the future? Have a look at the other graph, which shows what has been happening to leading indicators for the big three economies, the US, the eurozone and Japan since 1992. By contrast to the indicators for the eurozone and Japan, which have swung all over the place, US lead indicators were strongly positive right through until two years ago. That strength coincided with the solid growth performance that the US economy was producing. Then came a false warning of trouble.

In 1998, the US indicators suggested that there would be a cyclical downturn. There wasn't. Now they are suggesting the same thing again. Will they be wrong again?

The view of Merrill Lynch, which draw attention to these indicators in a recent newsletter, is that the soft landing forecast is intact. Growth is slowing and inflationary pressures remain modest. (They are also modest in the UK, as the Bank of England people noted yesterday.) That is absolutely right. Reason says everything will be all right.

But reason adds one little subtext to that. Look at the way all the leading indicators are turning downwards at the same time.

If all three chunks of the world economy go down together, maybe each will reinforce the other. Even Europe, despite the weak euro, is finding things slowing and Japan is suffering from the sharp appreciation of the yen, particularly against the euro.

These figures point to a global slowdown, bottoming probably in the first half of next year. But one cannot be wholly confident that when things go down they will necessarily recover as quickly as people hope. The danger is that in an interdependent world one plus one, plus one, might add up to more than three. That points to the 30 per cent option noted above.

And the American election? That is the dog that hasn't barked. Everyone is expecting the markets to loose their cool but they haven't.

Insofar as they are worried, they are worried about interest rates, the diminishing wealth effect with a market down 5 per cent on the year, what might happen to company earnings, whether the dot.com crash is really over, the illiquidity of junk bonds - just about everything except American politics.

So why should the wise political heads ponder the joys of defeat for their candidate? Just because whatever happens, even with a soft landing, the next four years are unlikely to be as good as the heady economic success story of the past four, indeed the past eight.

What I think happened (and I advance this tentatively) is that the communications revolution extended what was a solid cyclical recovery about two years beyond its natural life. The economy ought to have slowed down around 1998, but instead it experienced another burst of growth, driven by a once-in-50-years technological breakthrough.

What will happen now, I think, is the natural end of the cycle. Will it be more vicious because it was extended beyond its natural life? Not necessarily, because the boost was not artificial. The new technologies are real. Not a hard landing, but not a really soft one either. And since they cannot remember what even slower growth feels like, let alone recession, Americans may react badly - and show their irritation at the polling booths next time they turn out to vote.

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