The longest economic expansion in US history came to an abrupt end during the fourth quarter of 2000, as George W. Bush was preparing to take the helm at the White House. The important issue for us is the global consequences of a severe downturn in the world’s most powerful economy.

The US central bank, Federal Reserve Board (Fed) has acknowledged the extent of economic slow-down across America. Its statement read: ?The drag on demand and profits from rising energy costs, as well as eroding consumer confidence, reports of substantial shortfalls in sales and earnings, and stress in some segments of financial markets suggest that economic growth may be slowing further.?

A growing number of economists’ anticipate recession this year. The Merrill Lynch fund management survey shows that one in five US money managers are extremely bearish over economic prospects.

However, most economists’ proven forecasting records are generally poor.

A recent International Monetary Fund report found that model-based forecasts had failed to identify 60% of recessions in its member countries since 1980.

Causes of slow-down

Consumer confidence and spending power, the driving force underpinning a decade of strong expansion, is beginning to falter, mainly because of a stagnant Wall Street. The US equity market has taken a nose drive since last autumn. The High tech NASDAQ market ended the year a hefty 50% off its March 2000 peak. The Dow Jones Industrial Average, the benchmark US index, fell 6%, its first bearish performance in two decades.

Plummeting stock market valuations reduces private wealth, which in turn, can be detrimental to future consumption and business investment.

Corporate America is also facing a possible credit crunch, as financial markets fall and banks become more cautious in their lending.

US interest rates, at a nine-year high, have further increased personal and corporate debt levels. The Fed under the highly respected governorship of Alan Greenspan, on January 3rd lowered its key Fed funds rate (the interest rate banks charge on loans to one another) by 0.5% to 6%. Further reductions are anticipated to avert a major slow-down during the first half. But rate cuts take around six to nine months to feed into the real economy and stimulate an upturn in consumer and business spending power.

Growth in manufacturing industry was affected by stronger dollar exchange rates, and doubling of oil prices, which are now, however, declining.

A more worrying indicator is that high tech capital investment, which fuelled exceptional US growth especially since mid 1990s is now falling. A continuous decline in business investment in new technology will have negative effects on both output and future productivity growth - the very essence of America’s success during the nineties.

End of the bull run

The dollar, after its ?bull run’ last year, is likely to soften in 2001 if as expected, US interest rates move downward, and a deteriorating external sector - i.e. the huge current account deficit of $433bn in 2000 forecast by the Organisation for Economic Co-operation and Development (OECD) - seriously dents the attractions of US financial assets.

Substantial damage

A nasty recession in America, the world’s largest importer and a major source of outward foreign investment into both developed and developing countries, can inflict substantial damage to the world’s economic growth.

A US recession would manifest globally in four main areas: trade, capital flows, exchange rates and commodity markets. A severe US downturn will be disastrous for emerging markets’ export growth.

Malaysia, Mexico, Thailand, China, South Korea, Colombia and Hong Kong are some of the largest exporters to the US. Africa’s annual exports to America are worth $15bn.

George Soros, the billionaire investor and currency speculator, believes that emerging markets (heavily dependent on exports) have more to lose from a US slow-down. At worst, rising US unemployment could encourage trade protectionism at home.

If US capital markets suffer a bumpy ?hard-landing’ in response to falling corporate profits, then dwindling inward capital flows into US stocks and bonds will weaken the dollar against major currencies, like the yen, euro and sterling.

Should US markets go into a free-fall, most emerging markets would face renewed turmoil, although the latest OECD report states that ?risks of a sharp correction in the US stock market have probably receded.?

Easier to relax monetary policies?

On the other hand, subdued US growth could benefit some markets in East Asia and Latin America whose currency and monetary policies are pegged to the USAs. Falling US interest rates make it easier for the emerging markets’ central bankers to relax monetary policy, without risks of a run on currencies.

For corporate America, lower interest rates enhance earnings by reducing operating costs, and make shares more attractive relative to fixed income assets.

Commodity markets are particularly sensitive to America’s growth prospects. The US remains the globe’s biggest consumer of energy and base metals and a downturn in the US would have a severe effect on commodity prices.

On the positive side, lower oil prices can reduce inflationary pressures world-wide and improve balance of payments positions of developing countries, as well as help US manufacturers withstand the economic slow-down. But it would harm the prospects for major oil exporters, as in 1998.

A faltering economy

President Bush has undoubtedly inherited a faltering economy, but probably not a full-blown recession (which technically means two consecutive quarters of negative growth).

Larry Summers, the former Treasury Secretary expects 3% growth in 2001, down from a robust 5.2% last year. Forecasts from major investment banks, like Goldman Sachs and Merrill Lynch indicate real GDP growth of 2.0-2.5%.

The old saying, ?if America sneezes, the whole world gets a cold’ is largely true. Just ordinary growth would be bad news for international trade and investment.

The United States remains the engine of global economic expansion, and its sustained, buoyant health is of huge economic and political relevance to the world as a whole.

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