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Finance - Will the US economy stumble? |
George Bush is back in the White House and John Howard is back in Canberra. So everything stays the same.
Not quite. While hailed as great victories for the conservative forces of the world, it’s not going to be a gentle ride.
Iraq and the Middle East are still around. In addition economic problems are looming, particularly in the US. So far they’ve been ignored but this cannot go on indefinitely.
If markets are not convinced the US Administration has the problems under control, we could see a run on the US currency if confidence evaporates, a rise in interest rates and a plunge in the share market.
Some economists are suggesting that a few years from now, 2004 will be seen as the peak of the current business cycle for the US – not just the beginning of a long upward curve.
These problems are likely to make the second term rather difficult for the re-elected President.
Here we are talking about the twin deficits – the record US Federal budget deficit and the escalating US current account deficit. These problems have been around for some time so there is a sense of complacency amongst the US Administration.
Apparently some of its senior members do not even regard them as problems. The ones who were concerned have packed their bags and gone. This is a little scary, because as we all know, we all suffer when the US gets a headache.
Bush largely created the budget deficit – big tax cuts to investors and high-income earners coinciding with an expensive war in the Middle East.
The current account deficit is partly his fault too but admittedly it has been a burr in the US side for many years. The trouble is, under Bush it has been getting worse.
The current account deficit represents the difference between what the US sells overseas and what it buys. The difference, if it is a deficit, has to be funded in some way. Usually this is done by borrowing but it can also mean selling off US assets to foreigners. At an individual level this is the same as putting the bills on a credit card or selling the family silver.
According to most economists neither of the deficits is sustainable.
Something has to happen sooner or later and the corrections are unlikely to be too pleasant.
According to economists surveyed by the Wall Street Journal after the presidential election, cutting the record-high US budget deficit should be the top economic priority for the second term of President Bush.
More than half the 55 economists surveyed said that the budget deficit would be the biggest economic challenge for the Bush administration in the coming four years.
The US federal deficit hit a record high of US$413 billion dollars in the year to September 2004, compared with the previous record of US$377 billion dollars in 2003. They reckoned President Bush had to correct the deficit first even if it meant delays to further tax cuts and better social security and health care.
Failure to address the budget deficit will put pressure on US interest rates (the Government will have to borrow to finance the deficit and the extra demand for funds will push interest rates higher). But at least the US Administration can do something about the budget.
A trickier problem is the current account deficit. The President does not have a great deal of control. In 1998 the US current account deficit was 2.3 per cent of US GDP and even then most economists believed that at this level it was unsustainable. Six years later, the deficit is twice that size and is unlikely to narrow significantly over the next two years.
To finance the deficit the US has to keep borrowing and this is unsustainable. In smaller countries levels of debt similar to this have caused economic collapse and the removal of Governments. Only because the US is the US has it been able to get away with it for so long.
There is faith in the resilience of the US economy and a belief that the Government will fix things up. But an adjustment will have to take place. How and when will it happen?
No one knows for sure exactly when, however the way it happens is likely to involve a substantial fall in the US dollar against the major currencies of the world. It is also likely to mean that the US economy will have to slow down to stop a buoyant economy sucking in imports.
Stronger growth in the rest of the world will also help as it will boost US exports. Given the size of the US economy, this adjustment affects us all. There is even a slight chance that there could be a major run on the US dollar that could see it go into a type of free-fall.
The result would be chaos in all the major markets. But perhaps President Bush has it all under control.
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