This little graph tells us quite a large story, not only covering the past sixteen years, but also for the rest of this decade and possibly beyond. It shows two distinct phases in the recent economic history of the US. The first was between 1998 and 2001, a period where the actual output of the US economy was appreciably greater than the potential output. This shows the unsustainable boom of that period, leading to the inevitable bust at the beginning of this century. The second phase is from 2007 to the present, and possibly beyond. The credit crunch, financial bust, and the resultant recession have resulted in actual GDP falling appreciably short of potential GDP. In ball park terms, the US economy could expand by about three quarters of a trillion dollars just by fully using the unemployed and under-employed resources within the economy.
This is a cause for concern. The growth in the US economy over the past two years have been the result of a major fiscal stimulus (about $1.2 trillion) and an unprecedented monetary expansion through a double bout of quantitative easing (about $2.3 trillion). The monetary expansion ends this week. Whilst it is not suggested that a monetary contraction will take place, it is also highly unlikely that a third round of quantitative easing (QE) will take place. The removal of the monetary life support is likely to have something of a contractionary impact this winter (it takes about nine months for the impact to be felt). It may be the case that US unemployment starts to nudge back up towards 10% this year.
One of the areas in which the impact will be felt is in American fiscal policy. A good part of the two rounds of QE has been used in buying US Federal bonds. If this buyer of bonds is no longer in the market, then we can expect to start to see the yields on US Federal debt start to rise, which could start to place a strain on the US Federal deficit. At some point, the US President – if not the current one, then certainly the next one – will have to tackle this issue. It is not too difficult to foresee a period of fiscal austerity in the US, akin to the austerity measures now being enacted across Europe, in the later part of this decade.
This has a number of implications. Firstly, it means that the US will no longer be able to afford expensive overseas military engagements. Whilst this may be something of a shock to Americans, it will be a greater shock in East Asia where nations such as Japan, South Korea, and Taiwan still rely upon the US military guarantee. It will also have an impact in Europe, where the European members of NATO have been free riders on American military spending for decades. Second, it means that America will no longer be able to afford its poor. American welfare (including healthcare) is not exactly generous by OECD standards. Should that be pared back significantly, then we may see a degree of social unrest within the US that we haven’t quite seen before. Thirdly, it means that US seniors will have to rely upon their own provision for the future. In an economy where the costs of eldercare (including medication) are rising significantly faster than incomes in retirement, those retiring Boomers who haven’t laid much in reserve will face quite a constrained future. They could well become part of the poor that America can no longer afford.
And all of this presumes that US Sovereign Debt is not significantly downgraded from AAA. If it is, then all of the vicious cycle described above, becomes even more vicious and on a faster timescale. The key to avoiding this future is the generation of a political consensus in Washington that is prepared to take hard decisions about raising taxes and reducing spending commitments. It requires the sort of political courage that we can’t quite see in Washington at the moment. What we do see is a lot of partisan bickering that is putting self-interest ahead of the national interest. There isn’t even a consensus that America is facing a problem, let alone finding a solution.
But then, perhaps this merely reflects a social preference? American society seems to prefer immediate consumption over future security, in the belief that the good times will go on forever. This is not a preference that I share, but then, who am I to criticise the choices of others?
http://www.economist.com/node/18834323?story_id=18834323
© The European Futures Observatory 2011
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