Turbocharged growth for the US cannot continue

Whatever one thinks of US President Donald Trump, it’s hard to deny that much of America is feeling great again.

Surveys show that consumers have been this confident only twice before, at the height of the economic booms of the 1960s and 1990s, and their mood is bright across income groups, not just among the rich. Small business confidence has not been higher since the surveys began nearly five decades ago.

The ‘misery index’, invented in the 1970s to describe the agonising combination of inflation and unemployment, is now just 6 per cent, matching the lowest levels of the last half century.

This year in particular, the economy has performed exceptionally well. Among major economies, only the US has accelerated significantly in 2018, while Europe, Japan and many emerging economies have slowed markedly. The Commerce Department reported that the economy grew at a very strong pace of 3.5 per cent in the third quarter, putting it on track for its best year in more than a decade.

This raises a question: Why has the stock market, which normally rises when investors anticipate strong economic growth, been gyrating wildly?

Investors may now be expecting America to peak after a hot decade. Even with recent setbacks, the performance gap between the US stock market and the rest of the global markets is close to a 100-year high. Money flowing into the US has also driven up the value of the dollar, which has never been more dominant as the world’s preferred currency.

Trump doubters say that this boom began before he took office, in the aftermath of the global financial crisis of 2008, and they have a point. With its more flexible economic system, the US responded faster than its peers to the debt problems exposed by the crisis. The US forced households and troubled financial institutions to rapidly reduce their debt, and easy money provided by the Federal Reserve allowed them to start spending again.

Money also flowed into the giant tech companies that have underpinned the American economic surge.

Policies of consumption

Just as the 1980s belonged to Japan and the 2000s to emerging nations, the last decade belonged to America. Still, the gap in performance between America and the rest of the world has widened in the last two years under Trump, as his tax cuts and deregulation turbocharged the American economy and its markets. His policies have spurred consumption, and have incentivised companies to buy back more of their stock and bring home some of the money they had stashed overseas.

But economies that are hot in one decade rarely stay hot in the next. Every boom eventually creates excesses that sow the seeds of its own destruction, and the excesses that could end the American decade are coming into view.

The US economy has been expanding for nine years in a row, and if this streak carries on until August next year, it will be the longest economic expansion in the country’s history. Within a few years after the crisis of 2008, American companies had started running up debts again. It’s not unusual for companies to get overconfident and become saddled with heavy debts late in an expansion.

But it is unusual to see the government follow suit, as it has this time. Owing in part to the Trump tax cuts, the US budget deficit is now around 4 per cent of gross domestic product — the highest it has been outside the immediate aftermath of a recession or a war.

That will make it very hard for the government to keep stimulating the economy. Growth is expected to slow next year as the impact of the tax cuts fades and the strong dollar cuts into exports. The Fed has been raising rates, and the end of the long easy money party is starting to have an impact on the housing and stock markets, helping to explain the recent correction.

Thriving in cycles

Nonetheless, the US stock market is still swollen — and it seems unlikely to keep expanding from here. The stock market is now 60 per cent larger than the American economy, a scale it has reached only twice in the past century, during the manias of the 1920s and late 1990s. Moreover, the giant tech companies that have been driving the economy and markets now face a regulatory backlash that could cut into their extraordinarily high profit margins.

Trump haters may be tempted to conclude from all this that he is about to lead America into a sudden decline, but that is not the point. This American decade started under President Barack Obama, continued under Trump and survived congressional gridlock throughout, showing that the economy often rises above politics. The economy is driven less by ideology than by its own internal cycles, and this cycle has been turning in America’s favour for so long that it is unlikely to last much longer.

While the excesses of corporate exuberance and government debt are rising in the US, countries from France to Brazil are in the cleanup phase that often precedes an economic comeback. Most are a long way from working out the excesses of the last decade, and they may suffer further setbacks. But they are approaching the start of a new cycle, while the US nears the end of an old one. If history is any guide, the next decade is less likely to be great for America than it is for the rest of the world.