Research Dept. News
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Monthly Report, num 291 - May 2006
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International review - United States
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US engine functioning but needs some fixing
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United States growing strongly with no inflation pressures…
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In the passages of the Capitol, one man’s name was being heard a lot. That man was not Chinese president Hu Jintao, who recently visited the United States, nor the all-powerful political advisor Karl Rove, but Rob Portman, former trade supervisor and now head of the Management and Budget Office. He is the US president’s best bet.
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Thanks to Portman, the Bush administration has been able to fairly successfully resist the call of the protectionists who, in looking for scapegoats, are accusing China of being the main cause of the growing foreign deficit. This is the blot on an economy which, on the other hand, is growing by 3.2% without causing inflation. No doubt, an appreciation of the renminbi and higher domestic consumption would help reduce China’s bilateral surplus with the United States but the excessive consumption of the Americans themselves lies closer at hand and is more relevant for correcting the foreign balance.
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…but mounting concern about trade and foreign deficits.
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A good way to begin would be to put some kind of order in the public purse and that is where the appointment of Portman comes in. Since 2000, the combination of tax cuts and increased government spending, criticized from all points of view, has not done any good either to the budgetary balance or the trade balance. Without Portman, it would have been necessary to take notice of possible protectionist outpourings.
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Consumer indicators show strength and optimism.
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Another major factor responsible for the foreign deficit is private consumption. It does not matter whether it is cold or hot or whether oil goes sky-high, consumption not only is holding up but increasing. Retail sales in March, excluding the volatile headings of motor vehicles and higher-cost petrol, grew by 8.7% year-to-year whereas a year ago they rose by 4.8%. As a result, up to now, consumer extravagance is well above the more and more powerful assault of energy on household budgets. On top of the oil problem comes the higher cost of electrical energy generated in gas-fuelled power stations, which offer more flexible production, and here price acts as a goad to other prices.
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In spite of solid growth and that the slowdown is much gentler than expected, despite the enthusiasm of consumers and the price increases in raw materials and energy, inflationary pressures are not showing up. The consumer price index (CPI) for March was down to 3.4% year-to-year while the underlying component (excluding energy and food) remains stuck at 2.1%. The figure was somewhat worse than expected because of clothing. But the complaints come not from the CPI itself but rather from the risk that in coming months these problems will show up in high levels of production capacity and, paradoxically, in the cooling down of the real estate market.
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Inflation under control but high levels for utilization of production capacity and rise in rentals seen as major risk.
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Housing is slowing down gradually, just as the Fed wanted to see. Sales are down and prices are rising less although still above 10% year-to-year. Behind this slowdown lies the increase in the average rate for mortgage loans which now is 6.5% for fixed term loans as against 5.8% a year ago so that to buy a house now is 7% more difficult than it was last Spring. This is bringing about a relative improvement in financial costs for those who live in rental housing, making this option more attractive, although it could result in rent increases.
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Thus, the present inflation on real estate assets will be replaced by consumer inflation, with an effect on the underlying component. In any case, the pressure on prices would coincide with factors in favour of a cooling down rather than those of overheating: a drop in housing prices, with a decrease in wealth effect as an aid to consumption, and smaller household budgets. All these factors would involve less consumer splurging, an hypothesis already present in general public feeling, as reflected in the confidence indices published by the Conference Board, where the perception of thecurrent situation is much higher than one year ago, but not in the evaluation of expectations. More moderate consumption would put a clamp on the much-feared increase in prices.
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In the same way, wage pressures seem to be under control. Some 590,000 new jobs were created in the first quarter of 2006, an enviable figure but below the 73,000 jobs created one month earlier. Job creation is still not pushing up wages which are scarcely maintaining their purchasing level. Indices for corporate activity and perception of conditions also testify to the present good economic situation. But it should be remembered that, as a result of low interest rates, contained wage levels and capital goods prices, profits stand at highs in terms of nominal GDP. Any change would take us away from these highs and bring about more cooling off.
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Imports from China increase foreign deficit but high levels of public and private consumption also add.
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The trade deficit stands at more than 6% of the gross domestic product (GDP), continues to increase and for the moment no end of this is in sight. In spite of the enormous bilateral deficit with China, which is in deficit with the rest of the world, the foreign imbalance is not a Chinese anomaly but rather an American one. Less fierce demand by consumers, a loss of strength in housing, a balanced budget and perhaps not such high corporate profits might contribute to the reduction of this imbalance.
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