American economic growth is solid not miraculous

JANET Yellen’s cautious message that the US Federal Reserve plans to raise interest rates to nip inflation in the bud - but it is in no hurry to do so - was probably the most important piece of news for the money markets in March 2015, writes World Review expert Professor Enrico Colombatto. Ms Yellen, chairman of the Fed, surprised market operators with her announcement. Few observers believe interest rates in the US will rise before July, and most doubt anything will happen before October 2015. The result is investors have sold some dollars and bought euros. The last data about the American economy is not exciting. Annual growth was expected to be about three per cent, but the last quarter of 2014 showed annualised growth just above two per cent. Data for the first quarter of 2015 is unlikely to be much better. News on corporate profits, exports, investments and spending on durable goods is also disappointing. The bright spots are the labour market with unemployment at 5.5 per cent and employment rising steadily, and inflation currently about zero. This might inch up a few decimal points by the end of the 2015, to the delight of central bankers and many traditional macroeconomists. Americans do not seem overly concerned - and for good reason. The big picture is that the job market is in relatively good shape and new opportunities are opening up every day. Americans have also seen the stock market reach all-time peaks with no signs of bearish behaviour, and the housing market is recovering. In other words, their wealth is not in jeopardy. There are plenty of experts predicting forthcoming crises of all sorts. For example, the American public debt is above 100 per cent of GDP, and although the price/earnings ratios do not seem high by historic standards, some fear the stock market is actually betting on an unsustainable growth in profits. This pessimistic view sees a mini-crash when profit expectations prove overly optimistic and investors draw in their horns. The American economy will not be growing at miraculous rates, but its fundamentals are solid. It appears the American authorities are no longer using monetary policies to drive the economy towards a given goal, but rather to avoid causing harm. If this is correct, the Fed is likely to follow events and stay as neutral as possible for the next few months - if not for longer. If the Fed continues to pursue a cautious monetary policy the value of the dollar will be driven by global politics - when tensions emerge, capital flows towards the dollar, which today is still considered the most reliable currency - and by what happens in the eurozone. If the US economy continues growing at an annual rate above two per cent; if growth in the eurozone remains sluggish - the European Commission predicts a 1.3 per cent increase in GDP for 2015; and if the European programme of quantitative easing continues unabated, the exchange rate may hover around its current levels for a while. European producers will benefit from the weakness of the euro compared with the dollar. However, a weak euro will not be enough to restore entrepreneurial confidence and boost output. Instead, producers will take advantage of the weak euro to increase their profits, which could possibly induce investors to buy stocks of those European companies exporting to dollar-denominated markets. By contrast, countries which are heavy importers of dollar-denominated goods and are unable to adjust their production structure quickly enough, will suffer. A weak domestic currency is welcome by import-competing firms, but may be ruinous for those industries which are heavily dependent on dollar-denominated imports, and fail to attract or awaken new business ventures. It could be fatal for countries indebted in dollars, and expected to pay heavy rates of interest. These are still modest - about six per cent on medium-term maturities - in politically fragile undeveloped countries, but could be rising fast. Ratings agency Standard & Poor’s already considers debt issued by most sub-Saharan countries as ‘junk’. Gambia, Uganda, Nigeria and Angola are perhaps the first group of countries which could experience trouble. A number of countries, notably in Africa, could be falling victim to the strong-dollar trap. Their euro-denominated export markets have not expanded, while their dollar-priced supplies have become too expensive. Undeveloped economies in trouble will ask for help eventually. The euro will hardly recover as long as growth in the eurozone remains weak. But depreciation of the euro should not make us forget that many other currencies have followed the same fate and that these depreciations could provoke crises rather than enhanced competitiveness. For a more in-depth look at this subject with scenarios looking to future outcomes, go to our sister site: Geopolitical Information Service. Sign in for 3 Free Reports or Subscribe.

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