U.S. returns to grow but still faces debt problems

For the first time since Q2 ’08, the U.S economy returned to grow in Q3’ 09, +3.5% q/q annualized, ahead of the +3.2% q/q annualized expected by the consensus of economists. Nevertheless, positive third-quarter GDP growth did not help dispel the uncertainty surrounding the US economic outlook as the fiscal stimulus implemented in Q3 comes to an end. Indeed, economic growth in Q3 was driven by the measures adopted by the Obama administration to rescue the residential and automotive sectors. A clear example is the 22.3% increase q/q annualized in third-quarter car sales thanks to the "cash for clunkers" programme, which accounted for 1% of total GDP growth. But car and home sales (-3.6% in September) returned to fall once the incentive programme ended.

Not surprisingly, the recent recovery has been looked with scepticism by consumers, as indicated by the Conference Board’s consumer confidence index, which dropped from 53.4 to 47.7 in October. The negative trend in the labour market was the main reason behind a weakening consumer confidence. Indeed, despite early signs of improvement in the economic cycle, the unemployment rate continues to remain high (9.8% in September), and is expected to deteriorate further in 2010 (above 10%). The persistent rise in foreclosures is another negative factor affecting consumers, who will likely further increase their savings rate above 3.3% of disposable income in the third quarter.

Economists, though believing that the worst is finally behind them, consider the Q3 ’09 improvement of a transitory nature and are looking for a further slowdown in Q4 ‘09, when growth should come in at 2.4% and stay at this level throughout 2010, before slightly improving to 2.8% in 2011. Therefore the "new normal" scenario set out by PIMCO bond manager Bill Gross, who projected the U.S. economy to experience many years of growth below the average of the last 60 years (3.4%), seems to be very likely.

The economic imbalances that have plunged the U.S. into recession and that are far from solved remain the most serious risk factor facing the medium-term U.S. economic prospect. As indicated by the latest GDP data, US economic growth continues to be highly dependent on personal spending, which has steadily accounted for 71% of GDP over recent quarters. With the unemployment rate likely to increase further going forward, estimating a sharp rise in personal consumption over the coming months remains somewhat risky, even though the recent stock market recovery has increased both the ratio of total household debt to total household assets and the ratio of net worth to disposable income. The household sector deleverage is likely to weigh on personal consumption and the labour market. Data from the Federal Reserve for the last few quarters, in fact, have shown that households are gradually reducing their debt pile (-168bn dollars from the record peak hit in Q2 2008), although the ratio to GDP remains close to 97% due to the GDP decline in the first half of 2009.

With companies also committed to reducing their debt level (-50bn in Q2 compared to Q1), the U.S. economy is highly unlikely to be driven by a sharp upswing in investment in the coming quarters.

While a narrowing of U.S. household and corporate debt is positive, a rise in federal debt is cause for concern. It accounted for 51% of Q2 09 GDP from 44% in 2008, and is seen mounting further in the months to come. According to the Congressional Budget Office, public debt held by private individuals should achieve 61% in 2010 and hit an all-time high of 67.8% in 2019. However, many analysts have projected an increase in the debt ratio up to 100% of GDP over the next few years. Consequently, even government spending should hardly be able to underpin economic growth in the quarters ahead.

All in all, only an increase in exports appears to be able to provide a boost to the economy, even though third quarter trade balance data showed that relying on net foreign demand may prove illusory. Indeed, a slight improvement in consumer spending was enough to widen the external deficit to 348bn dollars from 330bn in Q2 despite the weak U.S. Dollar, hence breaking a downward trend for net trade deficit that had lasted since 2007.

The problem of excess borrowing in the U.S. economy might be still far from being solved and weigh on economic growth for several years. As shown in the chart below, in fact, the total debt level, excluding state and local government debt, has neared 220% of GDP this year and is unlikely to decrease in the years to come. U.S. authorities might well decide to reduce the debt burden by increasing inflation. This would cause serious damage to the entire global economy, which would have to search for a new growth trigger.

US economy still unbalanced

Rebalancing global imbalances: that is what major economists have always considered crucial for the international economy to make a lasting exit from the crisis that began in 2007 and became even more severe following the Lehman Brothers bankruptcy in September 2008. An economic growth still based exclusively on US consumption, which is driven by a booming real estate sector and buoyant credit markets, with other leading international economies (Germany, China, and emerging countries) benefiting from exports, is no longer sustainable. Several months after the outbreak of the crisis - the US officially entered into recession in December 2007 - it is essential to check whether these imbalances, over-indebtedness in the US in particular, have been healed to see if the long-awaited recovery of which we glimpse the first signs can be considered robust and lasting, or if it might be only of a temporary nature given the massive fiscal and monetary stimulus enacted at the international level. The signals coming from the United States, Europe and China are hardly encouraging. Most of the imbalances that have plunged the world economy into crisis are still far from being resolved and new sources of concern are already surfacing.

First, US consumer confidence data do not give grounds for optimism about the country’s medium-term economic growth prospects, albeit showing that US consumers are on track to correct the excesses of the past. Indeed, the recent decline in consumer spending in absolute terms (-1.7% in Q1 2009 vs. the high hit in Q2 2008) may point to a further moderation in household consumption growth going forward. However, the share of personal spending as a percentage of GDP is still well above the 70% threshold and firmly above the average for 1947 / 2001 (the year in which it broke through the 70% mark for the first time ever), when it stood at 65%, thus suggesting that a decrease in the weight of personal consumption on the US has yet to materialise and may adversely affect growth in the medium term.

Second, the drop in total household debt from 13,900bn in Q3 2008 to 13,794bn in Q1 2009 is a first promising sign for the household deleveraging process in the US, which is still far from complete due to the massive debt pile built in recent years. Household debt, in fact, is still too high as a percentage both of GDP (97%) and of personal wealth (22%), which fell by more than 16% in the face of a deteriorating housing market and bearish equity market trend. Therefore, household leverage is higher than in the months immediately preceding the ongoing financial crisis. Household net worth dropped from the peak of 645% of disposable income achieved in 2006 to 467% in the first quarter of this year. Under this scenario and given the bad health of the labour market (the unemployment rate is expected to exceed 10% in coming months) the recent increase in the savings rate has come as no surprise. The May figure showed that the savings rate jumped to 6.9%, reflecting households’ willingness to preserve the increase in disposable income stemming from higher social transfers and despite lower wages. Hence, personal spending growth is likely to remain sluggish for several quarters.
Households’ more conservative approach to personal spending has also curtailed the current account deficit, which has been another cause for concern for the US economy, the dollar in particular, in recent years. Indeed, after peaking at 5.8 of GDP in 2006, the trade deficit narrowed to 4.9% of GDP in 2008 and could fall to 2.9 of GDP in 2009 should the first-quarter trend be confirmed.

However other variables suggest that over-indebtedness in the US (based on the Federal Reserve’s latest data the total debt of the household, corporate and public sectors soared from 138% of GDP in 1974 to 243% in 2008) may continue to weigh on the US economy for many years, constraining the growth potential. First US corporates’ debt grew further in Q1 both as a percentage of GDP (79%) and as a percentage of their assets (71.7%) .As things stand, corporate investments are likely to remain very weak for some time also in the face of a slowing consumption, and only a sharp upturn in exports might give them a boost.

But it is the robust increase in public sector debt (though almost universally considered necessary to sustain economic growth in coming years) that shows that US growth will likely continue to depend on an increase in total debt in coming years. The Congressional Budget Office’s estimates see a doubling of the federal debt over the next five years, with the share of private debt due to rise from 40.8% of GDP in 2008 to 71.3% in 2013 and 81.7% in 2019. With a total debt / GDP ratio of 243% in 2008, maintaining this same ratio would require a household and corporate debt reduction of about 15% in the five years ahead. Otherwise within five years the US debt level would even be higher than that which sparked the crisis in 2008. A possible second round of fiscal stimulus, which has been hypothesised by President Obama’s economic adviser Laura Tyson during the week, is clear evidence of the risk of a further deterioration in public accounts.