Consensus on U.S. growth this year is around 3.5%, and many economists and analysts expect the same growth rate, or a bit higher, in the years thereafter. But where will this expected growth come from?
This is the bright side of the medallion. There is, unfortunately, another side, which makes it really questionable how the U.S. could possibly attain a growth rate of 3.5% or higher for the coming years. There are several points that need to be made.
First, the deleveraging process is far from over. In fact, It didn’t even begin. From the high of the "credit bubble" in Q2 2008, it's true that consumers reduced consumer plus mortgage debt from $13.2 trillion to $12.5 trillion at the end of last year.
In conjunction with lower interest rates, this might look sufficient to make the consumer debt load more bearable. However, over the same period, public debt increased from $9.4 trillion towards $14.0 trillion, while non-financial sector debt didn’t change all that much. This means total U.S. debt (excluding financials) has increased by a whopping $3.9 trillion. When the deleveraging process truly starts, U.S. growth will likely be affected for years, as it's from a historical perspective quite "normal" after a simultaneously bursting of a property and credit bubble.
Second, Congress isn’t debating whether fiscal policy has to be tightened -- but by how much. The pressure for a more prudent fiscal policy will increase even more as Japan shows how important it is to have a financial buffer to accommodate a natural disaster or (another) financial crisis. Fiscal tightening is a huge swing from the fiscal stimulus position the U.S. economy currently enjoys.
Third, the Fed is moving slowly to prepare the markets for less monetary stimulus for the economy. Growth is gaining traction and inflation is creeping up. This makes the current ultra-loose monetary policy, which was designed to fight a severe deflationary recession, too loose, according to many economists. Fed members seem to subscribe to this view more and more. Another round of quantitative easing is therefore unlikely.
This brings us to the fourth argument. The consumer sector (which accounts for a bit more than 70% of U.S. GDP) has shown some life over the last few quarters. This could be attributed to higher wages (although this rise has been barely enough to compensate for inflation) and increasing confidence due to rising stock prices. But the most important support the consumer has had were higher government transfers (from $1.84 trillion in 2008 to $2.26 trillion in 2010) and lower taxes.
Unfortunately, U.S. government – both federal and local – is seeking ways to put its financial house in order, and higher taxes and/or lower transfers to consumers will likely be part of that. Furthermore, consumers’ balance sheets are threatened by declining house prices and the stock markets’ vulnerability to monetary tightening. With credit conditions relatively tight and the need to delever still in place, credit-financed consumption growth is some years off.
The big question revolves, then, around where consumption growth has to come from. Employment growth is barely enough to provide jobs for new entrants. A rapid improvement in employment growth is unlikely if monetary and fiscal tightening is going to bite. This means unemployment will stay elevated, with sluggish wage growth in the offing. As a consequence, income- and credit-based consumption growth are unlikely to provide the economic motor with the much-needed fuel that replaces the dwindling monetary and fiscal stimulus fuel.
This leaves us with the investment and net export sectors of the economy to justify a 3.5% growth expectation. Investments collapsed during the credit crisis, from $2.33 trillion in 2006 to $1.59 trillion in 2009, only to recover to $1.82 trillion last year. This means there is a lot of upside potential in order to return to the long term trend, even if adjusted for less demand for residential investments. This could give the economy a boost, but keep in mind that sluggish consumption growth will likely put a dent in investment spending plans. Pent-up investment demand will probably add to growth, but is unlikely to act as the new locomotive for the U.S. economy.
High export growth is contributing to growth as well. However, imports are growing again, especially with higher oil prices and weaker dollar. This means net exports -- the component that feeds directly into the GDP figures -- are declining again after three years of improvement. The export sector won’t save the day.
To conclude: The U.S. economy will grow over time, if only for the natural tendency of a free market economy to seek an increase of the well being of its citizens. However, forecasts of a 3.5% growth for the coming years are poised to be too optimistic, as fiscal and monetary stimulus that stimulated the economy over the past years will be withdrawn. Other sectors of the economy aren’t able, or aren’t big enough, to compensate for that.
Growth expectations of around 2% would suit the state of the U.S. economy more. If this is true, it will have profound implications for USD exchange rates and interest rates.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
