from Follow the Money

An unbalanced US economy continues to get more unbalanced

June 1, 2005

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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Yes, I am repeating myself. But the data is pretty clear.

Housing Prices. Up. Particularly in big cities on the coasts. Leading indicators for housing. Up. Check out Calculated Risk for more.

Manufacturing. Down. Ford and GM. Down. Both are still big employers, directly and indirectly, even if they are no longer big sources of profits.

I find it striking that the sectors that benefit from China’s voracious demand for US debt are doing well, while the sectors that face competition from China (and other countries) are not. As they say, the answer to any question in economics and finance right now is either China or hedge funds.

John Berry tells us that the Fed is not all that happy right now. I can see why.

I have a suspicion that US export growth is in the process of slowing significantly. Imports may not be, or may not be slowing as much. Higher housing prices, home equity and all. The US trade deficit may turn out to be quite large in q3, if not before. There is no sign that China’s export growth is slowing, and the US imports from China normally are higher in the second half of the year -- retailers have to build up inventory for the holiday season. And that also may be when the strong(er) dollar starts to really bite. The US is storing up one big adjustment when it has to start shifting resources out of housing back into tradables production. The US and the UK clearly grew faster than continental Europe and Japan over the past ten years. Their external deficits also grew over that period -- as domestic demand growth outstripped income growth. That almost certainly will reverse itself at some point in the next ten years. Maintaining strong US growth during that adjustment process could prove to be a challenge. We plan to put the vaunted flexibility of our economy to the test.

Earlier this year, Greenspan spoke of market forces that were poised to help reduce the US trade deficit. To paraphrase Greenspan’s comments about the "increasinly audible" voices calling for fiscal restraint, those market voices calling for restraint are barely audible right now.

They are totally absent in the housing market. The policy question -- noted by Alan Murray -- is what, if anything, the Fed should do to try to offset the absence of market pressure for adjustment.

I would not be totally shocked if the next Greenspan speech sounds a bit more like his November speech, and bit less like his February speech, or Bernanke’s savings glut speech. Too many people are starting to think savings does not matter.

That is not the Fed’s view, as John Berry’s column makes clear. The US can not draw on other people’s savings forever. Berry’s column draws heavily on comments from Lew Alexander, who, in addition to being Citi’s chief global economist, formerly was part of the Fed’s senior international staff. Alexander now forecasts a 7.5% of GDP current account deficit in 2006 -- that seems about right to me.

With a bit more emphasis on "the risk" and less on "without a financial crisis," this quote summarizes my view too:

Like Citigroup’s Alexander, Fed officials still believe the eventual reduction in the U.S. current account deficit can occur without causing a financial crisis. The larger the deficit relative to the size of the U.S. economy, the greater is the risk that they will be wrong.

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