Global economic growth accelerated for the third successive year in 2004, with world GDP rising by 4.6%. This was the best year since 2000, and it is tempting to think that international influences on the UK will now be more benign. Far from it. The global economy going into 2005 will constrain activity for several years to come.
The US is at the heart of problem. Since it accounts for one-fifth of global output, it is hardly surprising its influence stretches across all continents. The US led the world economy upward in the second-half of the 1990s and the easing of US growth at the turn of the century sparked a global slowdown. When the Bush administration relaxed both monetary and fiscal policies, it stimulated domestic demand and helped the world economy recover.
That period of expansion has now run its course and the resulting structural problems facing the US economy will have implications for the rest of the world. As he begins his second administration, Bush faces two major economic issues: a $400bn fiscal deficit (3% of GDP) and a balance of payments deficit of $700bn (5.6% of GDP).
On top of this, the personal savings ratio is close to zero, households have a negative financial balance, personal-sector debt is rising and the housing market is overvalued. Strong growth in 2004 raised inflation worries and so the Federal Reserve raised interest rates five times, from a 1% low to 2.25%. With the likelihood of more increases to come (to 3% at least), the debt-servicing costs on an indebted consumer will bite hard, just as the earlier fiscal stimulus wears off. A slowdown in US growth is clearly on the cards, starting in the second-half of 2005 and through to 2006. From almost 4.5% in 2004, the rise in GDP will drop to about 3.3% in 2005 and just over 2% in 2006.
For the rest of the world, the most obvious manifestation of imbalances in the US has been the relentless decline in the dollar. Against sterling, for example, it went from $1.46 in Q4 2001 to $1.92 three years later, while against the euro the fall was from 89 cents to $1.36 in the same period. With the expectation of continued strong US growth in the first-half of 2005, and the increasing cost of servicing foreign creditors who have been funding the deficit up until now, the account deficit is likely to get even bigger, and the dollar even weaker.
A depreciating currency, making imports dearer but exports cheaper, is one way a country can address an external deficit. But while this might help the US, it spells trouble for its trading partners, particularly those that look to exports to stimulate their economies. The eurozone is in this category. In the 12 countries as a whole, GDP growth, which was virtually flat at 0.5% in 2003, rose to an unimpressive 1.8% in 2004. But this year and next, it will turn down again. The stronger euro relative to the dollar will hurt exports and, given that consumer spending is already fragile and governments are up against Maastricht-imposed fiscal limits, a few more years of below-trend growth are on the cards for euroland.
Only once in the past 10 years has German GDP growth exceeded 2%. As government and employers continue to cut benefits, moreover, private savings will rise, which will add to the downward pressure on consumption. France started 2004 in buoyant style but growth tailed off as the year progressed. France, like Germany, will have sub-2% GDP in the next two years, which will do little to ease their 10% unemployment. In Italy, Spain and the Netherlands, relatively slow growth in 2004 will be even slower in 2005.
Japanese growth will get stuck in a soft patch, again because of a sharp slowdown in export growth. Neither the consumer nor the government will come to the rescue, and the 3% growth of 2004 will slip to under 1.5% in 2005. Impressive as the projected 7% rise in GDP in each of the next two years is, it will still imply a slowdown for China. This will, however, be more the result of policy tightening by the authorities to prevent overheating.
A currency depreciation, even of the magnitude recently experienced, will not be enough to correct the external imbalance in the US. Americans favour policy loosening and stronger growth elsewhere to boost US exports, but this is unlikely to happen. The alternative is a slowdown in the strong US domestic demand growth. This would certainly ease the US’s external deficit but would exacerbate export opportunities to the US and, given the significance of the US market to the global market, would act as a drag on future growth. This will have an impact on all parts of the global economy – for several years.