On Tuesday the Dow Jones Industrial Average rallied to hit a record high of 14,253.77 points. October 2007 marked the previous high before the plunge that ensued as a result of the global financial meltdown in 2008.
The Nasdaq Composite is just two per cent below its October 2007 record and all eyes are now on the S&P 500 which is still 36 per cent below the dot-com highs seen in the 2000s. For the most part the United States’ major stock markets have buoyed significantly during the past two years. What should we make of this surge in private asset prices? Has the US economy turned the corner? Not quite.
Though large corporations have strong balance sheets as a result of easy access to free money (very cheap financing) and soaring profits, broad US economic growth is still sputtering and employment is still below the pre-recession level; almost three per cent lower.
Given that stock markets are considered a leading indicator, the good news is that “smart money”, i.e., savvy investors are pretty upbeat about near-term US economic prospects. There are positive signs in US housing and manufacturing data. You may recall that pre-2007 the US economy was largely fuelled by housing and consumption which were spurred by low interest rates, stock market wealth effects and transient household wealth in the form of surging house prices.
Some of these ingredients have returned. The re-emergence of manufacturing as a dominant US sector and the prospect of what the Economist magazine referred to as “inshoring” (the opposite of offshoring) are also inspiring confidence in a sustained recovery, a real recovery. The main obstacles are the ominous clouds of European decline.
The European Union accounts for about 25 per cent of global GDP. Consequently, the mix of recessions and negligible growth among EU member states has been a tremendous drag on global economic growth. Austerity central (the EU), buffeted by high debt, has largely failed to stimulate meaningful growth and development.
With the United States lurching from one budget crisis to another, necessary fiscal stimuli to growth have been stymied. Most economists agree that the US economy would benefit substantially from major investment in infrastructure renewal, corporate tax reform to reduce loopholes and lower marginal rates, and government support of new growth areas like alternative energy and catalytic innovation.
Aggressive monetary policy action has been filling the void by providing life support to the US economy. The Federal Reserve has been printing money like crazy to facilitate what it calls Quantitative Easing. The benefits have been lower interest rates, a weakened US dollar which makes US exports cheaper, and the diversion of private capital from US treasuries and bonds to corporate bonds and stocks.
While creating an environment for big business to flourish and financial liquidity to abound, small and medium-sized businesses have largely been on the sidelines. This phenomenon partly explains the lagging employment growth and the tepid aggregate demand (consumption), which underlines a weak recovery.
The IMF has forecasted US economic growth of two per cent in 2013, down from 2.3 per cent in 2012. The global economy is expected to grow by 3.5 per cent this year, slightly lower than last year and lower than the 3.9 per cent growth in 2011. China, India, Brazil and Russia are all expected to post strong growth this year.
The EU, forecasted to emerge from its recession with paltry growth of 0.2 per cent, remains the largest drag on global economic growth. There are positive economic signs but risks remain. Look out for a bumpy 2013. Seize the emerging opportunities but proceed with caution.
“We must accept finite disappointment, but never lose infinite hope.” – Martin Luther King, Jr.
* Carlos R. Forte is a Commonwealth Scholar and Barbadian economist with local and international experience. C.R.Forte@gmail.com