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A Bullish Mirage

Good news about the U.S. economy is proliferating. The international media is littered with articles stating that the U.S. economy is forging ahead with rapidly rising profits. Yet neither the stock markets nor the currency market have taken any notice. Asking traders, nobody could offer a plausible reason. Yet there are two very simple tentative explanations: first, the economic news is good, but not good enough to meet the high-riding expectations; and second, the bulls are fully invested, and short- covering by the bears is finished.

Better-than-expected economic news, actually, is coming from all parts of the world. Asia, accounting for 24% of global GDP, is hitting 7.7% growth this year. Ex Japan, the economies are firing on all cylinders, with growth rates vastly outpacing current and expected U.S. GDP growth. The tiger in the group is China, with expected 11.5% growth this year. Common to all these countries are high levels of gross national saving, including depreciations (averaging almost 30% of GDP), and also high levels of gross investment (averaging between 22-23% of GDP).

The U.S. economy, accounting for a quarter of the world's GDP, is likely to finish 2003 with GDP growth of 2.9%. Gross national saving is hitting a low of 13.5%, while gross investments in the past few years have been hovering around 18% of GDP.

The euro area, accounting for 18% of global GDP, will exit the current year with barely 0.5% GDP growth. Both gross domestic savings and gross domestic investment equal on average between 20-21% of GDP.

While U.S. economic growth is increasingly lagging Asian growth, the global focus remains primarily on the U.S. economy as the world's supposed predestined locomotive, for the apparent reason that America's consumer is the world's greatest spender. Implicitly, the U.S. current-account deficit of about $560 billion per year reflects what Americans spend in excess of their current production and income.

Yet the Asian countries, ex Japan, have a second reason to run a surplus with the United States. It is the main source of the high-powered money of their banking systems. As their central banks are buying gargantuan amounts of surplus dollars, they create liquid reserves for their banks that foster the lending boom to their domestic producers. Vastly excessive reserve growth is creating vastly excessive money and credit growth, stimulating and financing an unprecedented investment boom, similar to that in Japan in the late 1980s.

Global activity data has kept surprising on the upside for months, and there has even developed speculation that unexpectedly strong global economic growth may fuel considerably higher inflation rates. Commodity prices, in the past generally an early indicator in this respect, have soared spectacularly. Given, moreover, years of extremely rampant money and credit growth around the world, accelerating inflation will be the next great surprise for many people.

All this raises many questions. It seems quite feasible that the Asian tigers, with their record-high savings and investment ratios, will continue to power ahead with runaway credit creation. Yet our fear rather is that some of them, in particular China, may derail into Japan-style bubble economies.

For us the greatest uncertainties are about the U.S. economy, its financial system and its currency. The great issue not only for America but also for the global economy is whether the U.S. economy has definitely reached the stage where economic growth has become self-sustaining. Or whether it may relapse into sluggish growth next year, if not recession. Looking at the markets, we have the impression that many people are struggling with this question.

On the surface, the report of real U.S. growth of 7.2% in the third quarter, later revised to 8.2%, was most impressive. Many commentators hailed it as the highest growth rate since 1984.

To us, the exciting growth number raised more questions than it answered. Yes, it was the U.S. economy's fastest sprint in 19 years. At the time, it was actually 7.3%, but this rate referred to GDP growth over the whole year. This time, it was an annualized quarterly growth rate of 2%, which is not always meaningful.

Considering that the U.S. economy's long-term growth potential is around 3%, it should be clear that after three years, during which annual real GDP growth has averaged 1.8%, it will still take a lot more demand and growth acceleration to remove the output gap that has accumulated in these years. It is also generally agreed that a sustained and sufficiently strong recovery of the economy is only possible with a prompt, brisk rebound of business fixed investment. The bullish consensus is satisfied that this is happening.

As reported, nonresidential business investment rose in the third quarter of 2003 by 11%, after 7.3% in the second quarter. For sure, these are impressive numbers, but the only thing that gives them this strength is the fact that the actual quarterly numbers have been annualized. The true non-annualized growth rates of 2.75% and 1.8% for the two quarters would have caused nothing but yawns.

But there is a second big snag in the reported investment numbers. As usual, it arises from the familiar statistical spin concerning the measurement of business investment in computers.

In real terms, or "chained" dollars, it increased over the full year until the third quarter of 2003 from $297.6 billion to $390.3 billion, that is, by $92.7 billion, of which $35.4 billion occurred in the third quarter. That is the statistical fiction; actual business spending in current dollars on computers increased over the same time by just $11.5 billion, from $76.8 billion to $88.3 billion, of which $5.9 billion was in the third quarter. In reality, measured in current dollars, nonresidential investment over the year increased overall by $46.2 billion. Among this total, computer investment soared by $93.1 billion, of which $81.6 billion came from the hedonic spin.

Each additional dollar spent on computers in the real GDP accounts during the year translated into eight additional "chained" dollars, accounting, by the way, for 26% of real GDP in this time. The difference between the two measures of business computer investments is exploding. So much for the trumpeted investment recovery.

As we have explained many times, these particular dollars are fictitious dollars that nobody has paid and nobody received. Obviously, such dollars inherently add nothing to profits.

Putting it briefly and bluntly: The trumpeted brisk rebound in U.S. business capital investment is another bullish mirage lacking any serious substance.

Given this reality, it seems likely that the coming year will find the U.S. "recovery" neither sufficiently robust nor constant enough to foster true self-sustaining economic growth in the U.S economy.


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