The Global Crisis: United States - Wall Street is worried: Spend, spend, spend in the land of plenty

UNITED STATES WALL STREET HAS WORRIES

"YOU'RE NOT going to get me to predict that the US economy will carry on expanding for another 20 years," says George Perry, a senior fellow at Brookings Institution in Washington. "But it is very healthy."

The country's longest peacetime expansion will end only when the Federal Reserve decides it has to start raising interest rates to fight inflation, according to this seasoned observer. With commodity prices falling and wage pressures negligible, he sees no danger of that for now.

The American economy has experienced an astonishing seven years of plenty since the last recession troughed in 1992. Is it being superstitious to believe that fast growth, negligible unemployment and low inflation simply cannot last?

The reason more and more economists are predicting a slowdown lies in the very reason for the long expansion. Consumers are spending like there's no tomorrow. That appears to say something very ominous about tomorrow.

The gloomy view is that the ordinary Americans driving the expansion will pull in their horns, probably because of a Wall Street crash, and start to rebuild their savings from the current historic low of zero. Never in all of US history has the private sector borrowed so much to finance its spending.

Typical forecasts from Wall Street economists suggest outright recession lies in store for the second half of this year. The very gloomiest see a potential repetition of the great crash of 1929. More individuals hold shares than at any time in the intervening 70 years. If share prices were to fall sharply, they would all feel a lot poorer. Rather than spending all their income as they are now doing in aggregate, they will start to save.

Some calculations of the impact of shares on wealth and spending suggest share prices would have to carry on rising exponentially even to keep growth on its long-term trend, never mind sustain it at the 5 per cent- plus pace it attained at the end of last year. And, Internet bubble or not, that simply is not going to happen.

Indeed, any setback in the stock market runs the risk of stemming the tide of foreign money invested in American assets. The US has become the world's biggest debtor nation, so much in hock that new investment is needed to pay the interest and dividends on existing foreign investment. The tide of finance is being sucked in by a record balance of payments deficit, in turn caused by high-spending American consumers and companies buying more in imports than they sell in exports.

If it starts to unravel, the dollar could plunge and touch off higher inflation as import prices rise. The Fed would have to raise interest rates then.

This is the outlook implied by, for example, the latest forecasts from the International Monetary Fund. Its concern is that any sharp slowdown in the US would make it impossible for the rest of the world to get through the continuing financial crisis without severe pain. A gradual adjustment would be the ideal, but many economists believe that such extreme circumstances will actually trigger extreme adjustments.

The IMF is well aware that its economic forecasts in the wake of the series of financial crises have been over-optimistic, partly because the governments of afflicted countries were reluctant to publish appropriately pessimistic growth forecasts. Privately, the IMF is concerned that the global economy is on the verge of a third wave of upheaval since the Asian crisis in the summer of 1997 and the Russian collapse in the summer of last year.

With Europe growing too slowly to mop up exports from Asia and Latin America, that puts a huge burden on the continuing might of the US economy. This American expansion needs to make history to prevent the world as a whole from a disastrous future.

Yet Mr Perry is not alone in his optimism. Administration officials are more cautious but equally insistent that the economy is fundamentally strong.

Robert Shapiro, under- secretary at the Commerce Department and a longstanding adviser to President Clinton, says: "The underlying strength of the US economy convinces me there is no danger of a great crash." Inflation is low, investment high, productivity improving and the economy free from distortions, he argues.

Past crises, such as the bankruptcy of "savings and loans" banks in the early 1990s, and the recession earlier this decade that forced a wave of corporate downsizing, have left the economy strong and flexible. He argues that the apparent sign of weakness - the trade deficit and reliance on foreign funds - is, in reality, a sign of American strength. "It does not signal great distortion in the economy, but rather relative weakness elsewhere in the world." The real weaknesses are not to be found on the big canvas of trade balances and financial flows, but in the microeconomic foundations of skill levels, embedded poverty and inequality. "The market economy is a great paradigm for producing wealth, but not for distributing it," says Mr Shapiro.