Absent of Major Political Energy Absent of major political or energy shocks, the U.S. economy is likely to continue on its current growth trajectory for a while. Income growth is very strong, inflation is subdued, money supply is plentiful, corporate profits extremely strong, and even employment is growing. So what's not to like? Given the very strong performance, the burden of proof rests squarely on the bears. There is a growing sense among notonly bears that the music is due to stop in this Goldilocks economy. The reasons most commonly given include housing, of course, with the savings rate, global labor arbitrage, and "China" among the other top contenders. Let's take these in turn. Housing is finally slowing down in most parts of the country, but the question is whether there is a crash in the making. The related question is whether American consumers will continue consuming absent equity withdrawals. I think both concerns are overblown. All housing markets are local, and some local markets probably will slump - as they should, given stratospheric prices. But in my view the fundamental driver behind the steady increase in house prices remains demographics, and these are changing only slowly. The link between housing wealth and consumption is, moreover, not very significant - according to recent studies, the propensity to spend out of income is 13-15 times higher than spending from increases in wealth. Moreover, the correlation is significantly lower in the U.S. than the U.K. or Australia. What about savings? Officially, the U.S. now has a negative savings rate. Putting aside issues of accuracy (the rate may be badly understated), I think we will see a positive if somewhat counterintuitive correlation between declining housing wealth and the savings rate. As house prices stabilize or even decline, some discretionary consumption will suffer, but more importantly, savings will actually increase. Why? Because as people start to realize that the housing bonanza may not continue foreever, they will "shift" their savings from real estate back to more traditional assets. "Shift" in quotation marks because many people have viewed their house as their largest savings bank, so why bother saving in a real bank? That mindset will change. I think we will see a 5%+ improvement in savings over the next 1-2 years, for this reason, supported by continued strong income and employment growth. The other major supposed "gotcha" is the jobless growth we have seen thanks to global labor arbitrage. In fact, employment growth has been strong in the U.S., but mainly among the self-employed and small firms (which don't show up in the headline employment figures). Larger firms have been extraordinarily disciplined about hiring, in part due to labor arbitrage but also because of strong productivity. More recently though, firms are hiring, pointing to a steadily improving employment picture. However, growth is focused on high-skilled people, which is strongly positive for overall income growth. The U.S. does have a problem with lack of low skilled jobs. I don't think there is an easy answer to this dilemma. It is a human and social issue, not a short-term economic issue. It may become a long term economic issue, depending on factors like education, openess to immigration, etc. In spite of my general optimism, however, I am less bullish now than 6-9 months ago. There are two reasons. Firstly, the financial markets are signaling a slowdown, and they are usually right. We are years into a strong growth cycle, and gravity will presumably assert itself. I am not sure exactly what the fundamental factors will be, but the "technical" signals are there - the growth momentum is slowing. Secondly, I am deeply worried about protectionism. Congress is putting up a huge "Arab investors go home" sign around the Dubai Ports deal. Though relative small in size, it is hugely symbolic, not just to the Arab world. Bush (huge credit to him) will veto a congressional ban, but regardless whether the veto sticks, the signal is unmistakable, with ripple effects we cannot begin to predict. Even more ominously, "China" is played up as a huge economic threat by most politicians. Whether the Schumer 27.5% income tarrif will pass or not, American politicians are playing with fire. Quotas or tarrifs imposed on China will merely shift imports to higher-cost exporters, causing inflation in the U.S. More seriously, the political repurcussions could have an impact on the financing of the $800b trade deficit. A financial crisis is not inconceivable in this scenario - remember that the world-wide depression in the 1930s was caused primarily not by some stock market crash in the U.S., but by the trade barriers imposed by politicians who got their economics exactly backwards. Thus, for the first time in some 15 years, there is a real risk that a very healthy economy can be seriously damaged by political action. That is reason for pause. I believe the financial markets are already signalling some of this concern. Regards David back to Articles Index