The US economy

inSight

04 Jul 2002

The US economy

A combination of unusual events in the US have introduced a period of extreme economic uncertainty and financial stress.

Many economic analysts, including the majority of those in the HKMA, are finding it exceedingly difficult to monitor and understand, let alone predict, developments in the US economy. Yet this is one of the most fundamental tasks of all macro-economic analysts, given the sheer size of the US economy and its financial markets, the importance of the US dollar as an international currency, and their influence on the economic well being of the rest of the world. There is so much uncertainty, reflecting a combination of unusual events, that past behavioural patterns do not necessarily help. Yet we all have to live with and, prepare ourselves as best as we can for this period of heightened uncertainty.

While we can leave forecasting to experts in the field, readers may be interested in three interlocking issues concerning the US economy, of which HKMA economists are particularly vigilant. They are: the sustainability of the recovery of domestic demand, the sustainability of the external imbalance, and the potential disruptions from the financial sector.

Monetary easing by the Federal Reserve Board has been effective, probably to an extent beyond the expectations of many, in boosting consumer confidence. Lower interest rates and the relaxation of financing terms have stimulated quite strong demand for durable consumer goods. But business non-inventory investment has continued to decline notwithstanding the much easier monetary conditions - recent expansion in production was largely the result of an increase in working hours. This contrast casts doubts on the sustainability of the improvement in consumer confidence. Of greater concern is the over-stretched household sector: household debt as a percentage of income is at an all-time high of above 100%. But let us at least hope that the rather sanguine expectations of US consumers about their income and wealth prospects, and on financing costs, which support their behaviour, can be realised. Whether or not this is possible is dependent, among other things, on how the other two issues play out.

After a brief respite last year, the US current account deficit appears to be growing again. Although running at around 4% of GDP the ratio is at least lower than that in 2000, there is now greater concern regarding its sustainability and the prospects for the exchange value of the US dollar. The reason is simply that it has become rather more doubtful whether US assets can regain the level of appeal to international investors as they did in the last boom. The pace of the economic recovery appears to be moderate and not supported by fixed investments. The implication of the need, given a more conservative view towards the return on US financial assets, for an increase in the net intake of foreign savings might be a combination of currency depreciation, declines in asset prices and a rise in domestic interest rates. These obviously have further implications for the sustainability of the economic recovery. We are already seeing a weaker US dollar and predictions by private sector analysts of further weakness. There has also been a significant decline in equity prices. Thankfully, however, this has so far been quite orderly and there are as yet no adverse signs on the inflation front to justify higher interest rates. So let us hope that this inevitable adjustment in the freely floating exchange rates among the G-3 currencies will continue to be orderly. But the risk of sharp and destabilising movements is always there.

Indeed, financial markets play a key role in determining how economic events unfold. Globalisation has made this more so. In a way, by virtue of the depth and diversity of its financial markets, the US has been fortunate that this has tended on balance to buffer economic instability rather than to exacerbate it - witness the financial sector's response to the burst of the technology bubble and the terrorist attacks. The financial sector has provided an environment very conducive to adjustments in the real sector being carried out in an orderly manner. But I fear that US financial markets are now also experiencing increasing stress from several fronts. Security concerns from renewed terrorist threats at home to rising military tension in the Middle East are but one potential cause of disruption. A more pressing issue is whether corporate financiers can restore investors - confidence, both in terms of the latter's expectations of investment returns and their perception of professional integrity within the finance industry. There are also concerns over regulatory deficiencies, which have cast doubts on the credibility of market practitioners from auditors to stock analysts. Again, let us hope that current efforts to reform the relevant areas will pre-empt any significant deterioration in the effectiveness of the stabilising role that the financial sector in the US has been playing.

My apologies for leaving so much to hope!

 

Joseph Yam

4 July 2002

 

Click here for previous articles in this column.

 

Document in Word format

Latest inSight
Last revision date : 04 July 2002