/ 6 January 2006

US economy set to disappoint scaremongers

The global economy surprised most people yet again last year and grew nearly as fast as 2004’s 30-year high of 5%, in spite of surging oil prices and a sharp tightening of monetary policy in the United States, which is still the world’s biggest economy by far.

Dire warnings at the beginning of the year that massive global imbalances would cause a slowdown in the US economy, a collapse in the dollar — and possibly a world recession — proved well wide of the mark.

But some of those same worries and problems will exist throughout 2006; they have not gone away.

This year is likely to be dominated by what happens to oil prices, a further recovery in parts of the world economy, such as Japan and Germany, which have been weak up to now, and rising interest rates in many major economies as central banks seek to mop up the ultra-cheap money that has fuelled a global housing boom for the past three years.

To start with the giant US economy, it is hard not to be impressed by how it shrugged off the jump in petrol and other energy prices last year and the devastation caused by hurricanes in New Orleans and elsewhere, and just kept on growing. Latest figures showed that growth reached an annualised 4,1% in the third quarter of last year, in spite of a series of steady rises in interest rates from the US Federal Reserve since the low point of summer 2004. Since then, the interest rates have been raised 13 times to 4,25%. Most analysts expect a further two or three rises in the coming months as the Federal Reserve raises rates to a neutral level that no longer stimulates the economy.

The first significant economic event for the US, and the world, will be the departure from office at the end of this month of the veteran Federal Reserve chief Alan Greenspan, after 18 years at the helm. He will go out on a high, credited with steering the American economy out of a potentially huge recession in the wake of the dotcom bubble bursting in 2000. He may be getting out just in time, though, and if things go badly wrong in the next year or two, his legacy may not be as good as it looks right now.

Americans are carrying big debts and sitting on homes that have soared in value. If the housing market bursts, the whole world will know about it, because the American consumer, who would almost certainly stop spending, has been a key prop of the world economy for the past five years. Much of the spending of recent years has been on the back of higher house prices, as US consumers have been treating their homes like a cash machine by remortgaging to release equity. This also happened in Britain, although the process has slowed right down now.

There are signs that the housing market is starting to slow in the US, and that process is likely to continue throughout 2006. The deceleration in house prices in Britain and Australia, though, has provided some hope that the American housing market can slowly deflate rather than burst.

With higher interest rates and continuing high oil prices, it seems unlikely that the US will be able to maintain the same momentum it has enjoyed this year, but growth of 3% or more still looks perfectly possible and will still be among the strongest rates of growth managed anywhere — except, of course, for China and India.

All of which means that any narrowing of the enormous US current account deficit, which is now more than $800-billion or 6% of the economy, is a distant prospect for this year. The conventional wisdom is that at some point the US economy must grow more slowly — importing less and exporting more thanks to a weaker dollar — if it is to make any dent in the deficit.

And what of oil prices this year? Having surged to more than $70 a barrel at the time of Hurricane Katrina, it has settled back to about $60 a barrel in the past couple of months, although the latest scare on Russian gas exports may see some market anxiety.

China will continue to feature prominently this year. If its recent enormous upward revisions in the size of its economy are genuine — and there is little reason not to think so — then China is now the world’s fourth-largest economy and has pushed Britain into fifth place. China is likely to show further breathtaking growth this year after expansion of nearly 10% last year.

This year is likely to see a recovery, at last, in both the Japanese and German economies, the world’s second and third-largest economies respectively. This is a real positive because the US and China have had to provide the main impetus for world growth in recent years while Japan and Germany stagnated.

So, overall, the outlook is a fairly benign one, with growth becoming more evenly spread around the world. The risks of a dollar tumble or slump in the US economy remain. But those doomsayers who have predicted catastrophe for the past three years have been proved wrong each time. This year looks unlikely to be much different. — Â