... based on the fundamentals that could be this ...
economist.com
America's economy
A hard act to follow
May 2nd 2002
From The Economist print edition
Do not expect America's extraordinary growth to be sustained
ON THE face of it, America's economy is roaring back. In real terms, its GDP grew at an annual rate of 5.8% in the first quarter. It leaves the rest of the world far behind: Britain's economy grew by just 0.3% in the same quarter, while the pace for Japan and the euro area is reckoned to have been no more than 1-2%. America's numbers look almost too good to be true—which may be why they were followed by falls in share prices and the dollar.
Dig beneath the headline figure for growth and America's performance looks less miraculous. Almost four-fifths of the bounce in GDP came from firms reducing their inventories at a slower pace than in the previous quarter, and from a big jump in government spending. Defence spending grew at an annual rate of 20%. At the same time, residential construction, up an annualised 16%, was given a temporary boost by one of the mildest winters on record. Total final sales (which does not count changes in inventories) rose at an annual rate of only 2.6%, If one also strips out the jump in defence spending and, to take a rough guess, half of an unsustainable boom in construction, then growth falls to a mere 1.5%.
Consumer spending rose by a reasonable 3.5%, but fixed investment by firms fell, for the fifth consecutive quarter. Alan Greenspan, the chairman of the Federal Reserve, has said repeatedly that a pick-up in investment is critical for a sustained economic recovery. But that, in turn, requires stronger profits.
The new GDP numbers not only showed that growth is less robust than it seems, but that inflation is unusually weak. The GDP deflator—the amount by which nominal GDP is adjusted to take inflation into account—rose at an annual rate of only 0.8% in the first quarter, to give a year-on-year rise of 1.3%. It will probably fall further: in the past, the GDP deflator has fallen on average by more than one percentage point in the first year of a recovery, as productivity has rebounded faster than costs.
An unusually low rate of inflation, combined with uncertainties about the strength of the recovery, has two big implications. First, the Federal Reserve is unlikely to raise interest rates in the near future. It will not want to run the risk of allowing inflation to get too close to zero, where options for conducting monetary policy rapidly dwindle. Second, the lack of pricing power is likely to result in a weaker rebound in profits than in previous recoveries, dampening stockmarket hopes.
The S&P 500 index remains one-third below its 2000 peak. Uncertainty about profits is not the only factor that weighs on share prices. Lombard Street Research points to something else that may hold down equities: tighter liquidity. America's broad-money supply, measured by M3, has slowed sharply in the past three months. Usually, when the money supply grows faster than GDP, excess liquidity spills into financial markets—as happened late last year. When money-growth falls below GDP growth, liquidity tends to be drained out of markets, pushing down share prices. Were the stockmarket to slide further, strong consumer spending, the main driver of GDP growth in the first quarter, might come into question. |
