[Mb-civic] Buttonwood Slowing to a trot Economist

Wed Aug 11 12:09:06 PDT 2004

Buttonwood 

Slowing to a trot

Aug 10th 2004 
>From The Economist Global Agenda

How sharply will the American economy slow down? And what will it mean for
financial markets?

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BUTTONWOOD is back, refreshed, from his holiday in Ireland, his motor
neurones positively zinging. One of the many highlights was a ride on the
beach near Kinsale. There was, though, some questioning of your columnist¹s
horsemanship: Buttonwood thought he had been galloping, but daughter number
two said that, no, he had merely cantered. There is less doubt, however,
about the speed at which the American economy is now travelling. A gallop it
is not, nor even a canter. In the past couple of weeks, evidence of slowing
has mounted, most notably in the extraordinarily dismal payrolls number that
was released on Friday August 6th. Only 32,000 jobs were created in July‹a
mere seventh or thereabouts of the number that most economists had expected.
The only market that was enthused was the Treasury market, where bad news
tends to be good news, and where prices rose sharply.

Economists can broadly be divided into those (most of them) who laud Alan
Greenspan, the chairman of the Federal Reserve, as a latter-day Solomon, and
think that America is experiencing a normal recovery with a few problems;
and those (like your columnist) who think that those problems are
symptomatic of the fact that this recovery is different from all previous
recoveries since the second world war. The front-line in this battle has
been the jobs market. When the ³jobless recovery² started to produce jobs in
the late spring, bears went into hibernation. Now they are back, frisky and
growling, egged on by weak numbers and jittery stockmarkets. After recent
falls, the S&P 500 is now below where it started the year.

For this is the second month on the trot that jobs growth has been meagre:
June was bad too. Mr Greenspan had dismissed June¹s bad numbers as a soft
spot. Maybe July was another. But a second weak number becomes harder to
dismiss, especially when combined with other statistics showing a slowdown.
The economy as a whole grew by only 3% in the second quarter, for example,
compared with 4.5% in the first. And iron out that jobs volatility by
looking at the numbers in the round, points out Stephen King, chief
economist at HSBC, and as of last Friday the recent recovery had produced
fewer jobs than any recovery in the past 50 years.

Looked at another way, of course, this means that American companies are
wonderfully productive, hence their wonderful profits (which, after tax, are
their highest in 50 years). But even these may now be peaking. Pity the poor
consumer if and when they do, for profits are closely connected with the
employment rate: higher profits mean companies tend to hire more workers,
but the reverse is also true.

American consumers, of course, hold the key to growth. Betting against their
spendthrift habits has generally been a loser¹s game in recent years, but
only a fool could think that Americans can rely on the stockmarket or the
housing market to save on their behalf for ever. Saving is close to record
lows and the recovery has been built on a huge rise in household debt, the
cost of servicing which is close to record highs even though interest rates
are still so meagre. It is mainly American consumers¹ congenital inability
to save which is responsible for the country¹s huge and growing
current-account deficit.

Straws in the wind, perhaps, but there are signs that Americans are starting
to tighten their belts. Consumption fell by 0.7% in June. Not only are
household incomes rising more slowly than they have in previous recoveries,
but consumers face a welter of new claims on their wallets. Petrol prices
have now risen by about a quarter since the start of the year, thanks to a
crude-oil price of nearly $45 a barrel and a lack of refining capacity. The
high oil price is only one of a number of drags on consumption. Another is
that some temporary tax breaks are being withdrawn. A third is rising
interest rates: the Fed, as expected, raised its key rate by a quarter
point, to 1.5%, on Tuesday. American households used to be relatively immune
to rises in short-term rates, but they have discovered the joys of
floating-rate debt‹because the difference between short- and long-term rates
has been so great‹and are now much more exposed to rising short-term rates
than they were ten years ago.

Merrill Lynch calculates that all these drags (plus falling equity prices)
will have taken $190 billion out of consumers' wallets by the end of the
year. Oh, and the things they have been buying with borrowed money‹houses,
mainly‹are expensive. If and when they fall in price, consumers will have to
save real money, not rely on asset markets to do the job on their behalf.
More saving means less spending, and less spending almost certainly means an
economic slowdown.

Of course, oil prices could fall, the government could push through some
more tax breaks, and the Fed might prove less aggressive in pushing up
interest rates. The raft of weak data recently has already reduced
expectations about how far it will raise rates, and dampened inflationary
fears: buyers of inflation-indexed Treasury bonds (TIPs) now expect
inflation to average only 2.5% over the next ten years, compared with an
expectation of 2.8% at the end of May. As a result of all this, yields on
traditional bonds are now half a percentage point or so below the level they
reached in late June.

Intriguingly, despite all the inflationary scares, bond yields are not far
above where they started the year‹or, indeed, last year. Whether that is
good news for buyers of financial assets that are not Treasuries is a moot
point. It could well mean that the economy is about to slow down sharply,
which is unlikely to be favourable to risky assets. The question is: how
sharply? To a walk? A halt? In dressage, going backwards is called reining
back; in economics, it is called a recession.

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