Buttonwood
Slowing to a trot
Aug 10th 2004
From The Economist Global Agenda
SourceHow sharply will the American economy slow down? And what will it mean for financial markets?
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 columnist’s 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 “jobless recovery” 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 June’s 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 loser’s 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 consumers’ congenital inability to save which is responsible for the country’s 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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