The Hindu Business Line : US economy wobble

The US economy is giving off quite a few negative signals: A huge current account deficit of around 6.3 per cent of GDP; the Fed hiking the benchmark rate; a relatively high level of uneployment; and the low domestic savings rate.

In the last two decades the US Government has used expansionary monetary and fiscal policies to promote growth. This was to close the gap caused by the high import bill, chiefly because of the soaring crude oil prices and the not-so-robust growth in exports.

One result of this policy is the low interest rate, that has fuelled the property boom and lulled people into thinking that there is no need to save. The US government finances slipped from surplus to deficit. Yet, if the economy has not slipped into a crisis it is because of the inflows of capital from across world . But there are limits to how long the party can go on.

The dollar has already depreciated by about 17 per cent from February 2002 against major currencies. Reluctance of foreigners to invest in the US economy will put immediate pressure on Washington to respond with monetary policy tweaking. But this can raise the fiscal deficit and is a sure prescription for economic imbalance. Also, the unemployment rate of around 5 per cent may actually be understated. Some economists believe it is higher than what the Government claims.

Employment statistics

In an article A whiff of stagflation, in The New York Times, Mr Paul Krugman wrote that unemployment statistics counts only those who are actively looking for jobs. Every other indicator shows a situation much less favourable to workers than that in the 1990s. A lower fraction of the adult population is employed; the average duration of unemployment — a rough indicator of how long it takes laid-off workers to find new jobs — is much higher than it was in the 1990s.

All is not lost, yet

Despite all this, there are some signs in favour of the US economy. A current account imbalance is a sign of US strength, not weakness. For, this is seen as the result of foreigners rushing in to benefit from the country's highly productive and efficient economy. The net foreign investment in the US has increased sharply into government bonds rather than in shares of the corporate sector. This shows that the rest of the world is lending money to the US.

According to the Bank of International Settlement, Asian banks bought $440 billion worth of US bond in 2003 and $395 billion in 2004 (excluding bonds that banks buy in secondary markets aboard). So, in a way, the expansion in the US economy would not have happened if the rest of the world had not lent to it.

Moreover, current account deficit is much less compared to the total US wealth. The US households are worth around $30 trillion, while the annual foreign borrowing is $700 billion. Since 2000, there has been a rise in housing prices; the average citizen's house price is increasing by around 13 per cent a year. It does seem like a sign of speculation or bubble. This bubble cannot continue for long.

Together with an expensive Medicare and social security scheme, the aftermath of Hurricane Katrina, and soaring oil prices, there may be tough days ahead for the US. Maybe, the US is the world's biggest consumer. But that has still left the economy vulnerable.

It can turn the table by importing less and exporting more. It is not investing enough in the export sector, which accounts for less than 10 per cent of the economy. Its economic health is skewed heavily towards housing. Also, the US needs to reduce its consumption; if this is not done voluntarily, economic crises will force it to do so.

(The author is on the Faculty, International Business Area, Institute of Management, Nirma University of Science and Technology, Ahmedabad. Response can be sent to Deepak@nim.ac.in)