The Slow Road to Recovery

Two months ago, the stock market was telling us that deflation was on the way and that the US economy would be leading the world into a global recession. Since then the market has staged a strong rebound and people are feeling more optimistic again. My feeling, however, is that the excesses of the late 1990s bubble have only partly been dealt with and that until they have properly worked their way out of the system, the real recovery will remain elusive.

At a recent conference in London, David Hale, the chief economist of Zurich Financial Services, presented a bullish case for the US economy. Hale argued that despite the decline in the US stock market, which from its peak in 2000 to the recent trough in October had fallen in value by a sum equivalent to 90 per cent of GDP, the economy had shown tremendous resilience. He ascribed this to several factors.

First, the prompt response of the Federal Reserve to the slowdown by cutting interest rates. This enabled Americans to refinance an estimated $1.5 trillion of domestic mortgages this year. At the same time, they extracted some $130 billion from their housing equity to fuel consumer spending. In addition, low interest rates have boosted US house prices, which have been rising by around 8 per cent over the last few years, thus off-setting losses from the stock market. Secondly, Hale highlighted the stimulus to the US economy provided by the increase in US government spending due to post-11th September military expenditure. This has provided a demand boost to the economy equivalent to 4 per cent of GDP, the most dramatic increase in government outlays since the early 1980s. Thirdly, productivity growth has continued strongly into the slowdown and is currently running at over 5 per cent per annum. Finally, Hale argued that the US banking system was in a strong position since it has largely protected itself from bad loans through the use of credit insurance. Much of the financing for the telecoms boom, he observed, came from capital markets and thus the collapse had not damaged the banks.

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