Where are we? Take two headlines from Tuesday: "Nasdaq Hits 2-Year High"; "Dollar Hits Record Low vs. Euro." The two are related.
The technology-heavy Nasdaq stock market index has, like U.S. stocks in general, enjoyed an excellent run over the past couple of years. Meanwhile, the dollar has tumbled over the same period, particularly against the European single currency, the euro, which, at its current value of $1.26, is worth about one and half times as many dollars as it used to during its lowpoints of 2000 and 2001.
There is therefore a change in the U.S paradigm. Once it was strong growth, strong stock market, strong currency. Now it is strong growth, strong stock market, weak currency.
It is argued by some economists that this change is a healthy one. The United States has record trade and current account deficits. The weakening dollar can help to correct this. It makes U.S. goods more competitive and foreign ones less so. It makes it more inviting for foreign tourists to visit the United States and less inviting for Americans to travel overseas. Thus the United States' external accounts can improve and move closer to balance. But the weak dollar may not be enough to bring about the correction the U.S. economy requires; and it is also a reflection of a policy of cheap money that has helped bring about strong growth and a rising stock market.
Both the U.S. Federal Reserve and the government of President George W. Bush have ensured that money flows in quantity into the U.S. economy. The Fed Funds Rate, the benchmark short-term interest rate, controlled by the Fed, has been brought down to 1 percent. Fed Chairman Alan Greenspan has also sought to talk down longer term interest rates by assuring the markets that the short-term interest rate would be kept low and downplaying the risks of higher inflation. Meanwhile Bush has put money into Americans' pockets through tax rebates. And both Americans and the government have profited from lower interest rates to indebt themselves more and more.
The rise in debt in recent years -- years, it should be remembered, of low inflation -- is quite remarkable. The federal government's debt was reduced a little in the sunshine days of 1999 and 2000. But in the two years from the second quarter of 2001 to the second quarter of 2003 the federal debt rose by $563 billion, or 17 percent, to $3.9 trillion.
"Oh irresponsible government! Always borrowing in order to spend," Americans might say. But American households are not in a good position to point their finger. They have been on even increasing their borrowing even more rapidly. In those same two years, households' mortgage debt rose by $1.3 trillion, or $25.6 percent, to $6.45 trillion -- a huge sum, roughly equivalent to two thirds of U.S. annual GDP.
How about consumer credit? Its pace of growth is relatively modest, up by 9.8 percent in the past two years: a slowdown, for the average annual rate of growth over the ten years to the second quarter of 2003 is over 8 percent.
Businesses, too, have reduced the pace of their borrowing to a rise of just 4 percent per year in the past two years when the average annual pace over the past five (back to the second quarter of 1998) is of 7.6 percent.
In total, what debt figures point to is a lending binge. In the past three years, from the second quarter of 2000 to the second quarter of 2003, total debt in the United States rose by $3.8 trillion, or by almost 22 percent, and leading the way has been not the government but what we might term ordinary Americans: homeowners and consumers who increased their mortgage debt and consumer credit by $2.1 trillion in just three years.
It can be said that this rise in debt does not matter for most of it is backed by house price rises. House prices can't fall, can they?
Another point, too, is that house prices cannot reasonably be expected to keep rising. So the tide of fresh credit flowing into the economy from mortgages must wane--and is waning, according to the latest figures from the Mortgage Bankers Association. This is important because much of the fresh mortgage debt has been to refinance old mortgages and the fresh credit has been used to pay down more expensive mortgages and, for example, credit card debt--and to provide money for fresh consumption. This source of fresh funds for consumption, which helped to propel the U.S. economy to 8.2 percent growth in the third quarter, is going to dwindle. Where will fresh fuel come from?
While the numbers for debt and consumption in the U.S. economy keep spiralling, figures for saving do not stagnate but fall. In 1998 "personal saving," as measured by the Fed, amounted to $301.5 billion while the government saved $272.3 billion. Together with other private saving this made for gross saving in the economy of $1.65 trillion.
Move forward five years, to the second quarter of 2003. Personal saving has fallen to $268.1 billion. The deterioration in the government position is much more marked: to a deficit of $168 billion. The total level of saving in the economy is also down, to $1.5 trillion.
For years now, the U.S. consumer has just not stopped. Americans saved only 2.3 percent of their disposable income in 2002 and a little less than that in the first three quarters of 2003. The federal government and the federal reserve have given them every incentive to keep spending. With their real estate rising in value by an average of $794 billion per year from 1998 to 2002, Americans still feel the wealth effect, despite the fact that from 2000 to 2002 falls in stocks reduced overall household net worth--which had exploded in the stock boom of the 1990s.
No one in government tells Americans to save. The encouragement is always to spend, spend, spend, with the federal government itself now taking a lead.
Cheap money floods into the economy, feeds its growth, its inflation in house prices, its stock market--and the cheapening of the U.S. dollar. America goes on living beyond its means, as the federal and external deficits show. In the end it will have to pay.
(Global View is a weekly column commenting on issues of importance for the global economy. Comments to [email protected].)
