The scenario is a familiar one. The Americans lead a coalition that defeats Saddam Hussein in the Middle East but, less than two years later, the victorious President Bush is defeated by an obscure Democrat in the race for the White House. By common consent, ‘it (was) the economy, stupid’ that lost the Republicans the election.
Is it possible that what happened to George Bush senior in 1992 could happen to his son next year?
If the condition of the US economy is critical for George Bush junior’s re-election, it is also of great significance to many people for whom the US presidential election is of no interest. In Britain, for example, the performance of the US economy will matter more in the short term than any actions the Monetary Policy Committee is likely to take. This is because there is little the policymakers here can do to stimulate activity in the domestic economy. Buoyed by a near 50-year low in interest rates and a record level of employment, British consumers continue to demonstrate that reports of their demise have been exaggerated. The government has now joined in the spending spree and, in Q2 this year, domestic demand rose by 4% on last year.
What dragged GDP growth down to under 2% was a 5.3% fall in exports, coupled with a 1.8% rise in imports. This reflects the fragility of our key overseas markets rather than a lack of competitiveness of British goods. Projections of growth in the eurozone have been regularly revised down, with France looking as if it could well join Germany, the Netherlands and Italy in a technical recession. Japan, the world’s second-largest economy, has been in economic quarantine for years.
Then there is the US, the world’s largest economy and still the UK’s single largest export market. On its own, the US accounts for one-fifth of global output and the £28bn of exports the UK sold to the US in 2002 represented 15% of our exports of goods. There are also strong Anglo-American investment links. Not only is the US the preferred location for the overseas subsidiaries of many British companies, but the UK is also the first-choice European base for American companies. Hence, the US matters to Britain’s balance of payments.
The US is just as important for the rest of the world. A booming America acted as the engine of growth for the global economy and everyone else piggy-backed off it. Between 1996 and 2000, the US economy grew by a fifth, a remarkable rate fuelled by rapid uptake of technologies in IT and telecoms.
This, in turn, laid the foundations for a huge surge in equity prices and a boom in consumption.
Imports flooded into the US and, by 2000, the US was borrowing $1bn a day to keep its economy going. The balance of payments deficit soared to an unsustainable $400bn. When the dotcom bubble burst and equity prices tumbled, growth in the US headed south, with the consequences felt well beyond its own shores, even before the uncertainty created by September 11.
Difficult as the outlook seemed at one stage, it is easy to underestimate the resilience of the US economy. There were serious problems, not least overinvestment and a loss of corporate credibility, after a series of Wall Street scandals, but activity held up better than expected and recent figures suggest growth next year will be robust.
It should never be forgotten that what drives business in America is America. It is a huge, inward-looking economy that does not depend on the rest of the world. If, therefore, the policy response was appropriate and timely, the US economy could pull through in reasonable shape.
This happened, with Alan Greenspan cutting interest rates to 1% and President Bush reducing taxes by an amount equivalent to 5% of GDP over three years.
Factor in a boost to confidence coming from the toppling of Saddam Hussein and the positive results are starting to show. Although unemployment has edged up, there has been a modest recovery in equity prices and GDP should rise this year by about 2.5% and next by over 3%.
But the US is not out of the woods yet. The sizeable balance of payments deficit is still there (over 5% of GDP), to which has now been added a fiscal deficit of equal magnitude. The dilemma for policymakers is that reducing the fiscal deficit requires faster economic growth, which will worsen the external deficit. On the other hand, slowing the economy will ease the balance of payments burden, but widen the fiscal gap. The US may be caught between a rock and a hard place, but that is the day after tomorrow’s problem. Tomorrow’s is the presidential election, and Bush Jr does not want to go down the same path as his father.
Dennis Turner is chief economist at HSBC.
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