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Recovery is taking hold Samuel Brittan: Financial Times 12/09/03 In spite of unusual weather and Middle Eastern troubles, the prophets of doom have had a bad summer. Much less is now heard about "deflation", which was always a misdiagnosis of the problems facing the world economy, and much more about the pace of recovery. Growth in the industrial world is once more being led by the Anglo-Saxon countries, notably the US with some help from the UK. The US recession, such as it was, occurred in 2001 and the pessimists received some encouragement from the faltering US recovery of 2002, related to corporate scandals. But now the US economy is expanding vigorously. There has been a similar turn in the UK, where the strength of real gross domestic product has surprised many analysts. The Washington-based Institute for International Economics, which is no friend of the Bush administration, projects US growth at "better than 4 per cent", or well above trend for the next 12 months, and expects substantial job creation in the US during the fourth quarter of this year, which will gladden the heart of the ultra-Keynesian president. The institute expects most large economies to share in a mutually reinforcing world expansion. China and India are already the growth leaders. A modest Japanese recovery is expected to continue; and even the eurozone is expected to pick itself up, despite the weak German upswing. Goldman Sachs heads its most recent European Weekly Analyst with the question: "How fast will the ECB hike [interest rates]?" Its answer is: from the middle of next year, in line with market sentiment. In UK business circles talk is no longer of base rate reductions but of pleas to the Bank of England not to rush in with increases. Goldman expects the Bank to start tightening within the next six months, whereas it expects the US Fed to remain on hold until well into 2005. What are the threats to this benign prospect? The first is debt; the second imbalances. The third is concern about the "consumer society", which was first raised in the 1960s and 1970s and has since resurfaced at regular intervals. Does the health of western capitalism really depend on finding more and more gadgets and personal services, which the consumer at home or abroad will work or borrow to purchase? Will there be a point where "enough is enough", where a yearning for a less hectic pace of life takes over and we approach "the stationary state" enthusiastically outlined some 150 years ago by John Stuart Mill? These are important long-term questions. But for the near term a faltering in world growth would mainly reflect a failure of the economic mechanism rather than a deep change in attitudes. The debt threat is most prominent in the UK, where tabloid headlines about it are in danger of displacing even celebrity gossip. Problems could arise even without a general slowdown. Imagine an economist's dream world, in which sterling falls and exports and investment take over from the consumer as the driving force of growth. This situation could still be associated with many spectacular personal failures. That is the best rationalisation of the tabloid panic. The optimists reply that much higher personal debt ratios are now perfectly affordable because interest rates, both nominal and real, are lower. They also say that consumer debt should be compared not with income but with personal wealth. But this argument quickly becomes circular. Property values have taken over from equities, even in the US, as the mainstay of personal wealth. If they stop rising, personal wealth will cease to grow. The problem of imbalances is most obvious in the US. The Bush administration is pursuing a policy of guns and butter. The famous twin deficits - budget and current balance of payments - which were discussed so fruitlessly at so many international meetings in the 1980s, have now re-emerged. Both are running at 5 per cent of US GDP and could get larger. You do not have to be an Einstein or a Keynes to know what to do. As US recovery gathers momentum, taxes need to be raised or expenditure curbed. The US economy will survive if this does not happen, but with higher real interest rates and less real growth. The balance-of-payments deficit would take care of itself if sound internal policies were followed and the dollar were allowed to float freely. China and other Asian countries might find it in their own interests to allow their currencies to float upwards. But it is humiliating that the leaders of the main capitalist economy should go cap in hand to the government of an emerging economy, run by a nominally Communist dictatorship, to beg for help in devaluing the dollar. It is also a highly dangerous game. About half the US deficit is now financed by the purchase of dollar securities by Asian central banks, led by China. If Chinese leaders were suddenly to dump these dollars, the depreciation of the US currency might go much further than Washington had bargained for. In any case the bond market would take out its own insurance by marking down US government securities, thereby raising US long-term interest rates and cancelling out much or all of any stimulus provided by dollar depreciation. The twin deficits of the 1980s went away when people got bored with lecturing the US about them. The same could happen again. But unfortunately both George W. Bush and his friend Tony Blair confuse free enterprise economics with toadying to short-term business interests. My own guess is that, leaving aside the ever-present possibility of fresh terrorist outrages, North America and Europe will avoid spectacular crises; but they will face painful periods of adjustment when growth will disappoint. In common with the gold market, which this week reached a seven-year high, I am far from sure that inflation has been permanently defeated.
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