Ignacio de la Torre. Professor. IE Business School
8 December 2014
Just like falling dominoes, the effect that recovery in the US can have on the world economy will reach the furthest corners of the planet.
As a child, I'd always hear on the news: "When the US sneezes, the world catches a cold". So, conversely, when things speed up in the US, they have a knock-on effect throughout the rest of the world. This week, we've learnt that the US economy is growing at a rate of 3.9% annually. So, let's take a look at just what the significant implications of this growth are.
Firstly, the US consumer represents nearly one fifth of the world's GDP. So, if North Americans don't buy trousers during the first quarter of 2014 because they've stayed at home on account of snowstorms, that's bad news for the Chinese trouser manufacturer, just as it is for the German machinery manufacturer who exports the parts needed to manufacture said trousers to China. The strength of the US labour market, together with wages increasing 2% annually, drives consumption, which is increasing at a rate of almost 4%, or 2% in real terms. Given that the US is the world’s importer par excellence, the economic recovery of the international market is a direct consequence of economic acceleration in the US. Consequently, the World Trade Organisation (WTO) estimates that trade worldwide will double its rate of growth, from 2.5% in 2014 (following an atypical first quarter in the US) to 5% in 2015. This is good news for exporters, as well as for the world economy.
Secondly, North American investments are showing a strong increase, after many years of stagnation. This activity is the direct result of the underinvestment of the last few years, strong demand (consumption encourages investment in increased manufacturing output, since it is believed that said output will sell), and access to financing. This investment is, in turn, linked to contracts, which, presumably, will lead to more people in employment, and, consequently, more consumption. This is a virtuous circle which will end up having a positive effect throughout the rest of the world, on account of imports linked to investment and the resulting consumption.
Thirdly, although the monetary policies of the Federal Reserve System are, principally, designed with the objectives of the US in mind (i.e. price control and job creation), they have proved to be very beneficial for a considerable number of regions, particularly Europe, where the effects of the crisis have been felt far more keenly than in the US, the reason being that long-term interest rates in many countries are linked to long-term interest rates in the US, which, in turn, are linked to short-term interest rates (governed by the Federal Reserve System). The Federal Reserve System will initiate a cycle of increases; however, this will, in theory, be staggered over a long period of time. In other words, US monetary policy will continue to favour international demand.
Fourthly, the dollar continues its ascent, as a result of economic acceleration in the US, and minimal growth in the rest of the world. The consequence of this is the relative deterioration of the capacity of the US to export and, by extension, greater capacity for exporters to the US to increase activity, which, in turn, increases GDP throughout the rest of the world.
Now let's take a look at the causes and consequences of these hypotheses.
On the one hand, US GDP (price adjusted) is 5% higher than it was prior to the crisis. In the eurozone - where the GDP is similar (some 17 trillion dollars) - it is 2.5% lower. Furthermore, the US economy is growing at a rate of 4% annually, while Europe’s is growing at 0.6%. So, what are we doing wrong? Well, a lot of things, but two in particular stand out: (i) In the United States, bank financing is contributing to growth, whilst this is not yet the case in Europe (though it will be in 2015). This is because they have continued to maintain a financial system with significant periods of false balance sheets. In 2008, the Americans recapitalised their banking system, so it can be deduced that the banking system has contributed to the growth of GDP and, by extension, employment (with unemployment at 6% as opposed to 11% in the eurozone). In the eurozone, the banks' assets are equivalent to 3.4 times our GDP, so if there is a crisis, we get a really bad cold; what's more, the taxpayer has to stump up far more than in the US, where the banks' assets are equivalent to 0.8 times GDP; (ii) the capital market is equivalent to 0.9 times the GDP in the US. If there is a banking crisis, companies can finance it by means of the bond market. This has not been the case in Europe, which is one of the reasons why our manufacturing and employment have suffered so much, in comparative terms. Fortunately, this is in the process of being rectified.
Finally, the "negative" consequence of the economic recovery we're talking about in this article is the rise in interest rates that will attract capital to the US, which is of considerable worry to those countries with an operating deficit, which must rely on external capital to maintain the level of GDP. Fortunately, the eurozone is an exporter of net capital (2.5% of GDP - more than €270 billion; possibly the highest current account surplus in the history of mankind). All the same, other countries with comparable deficits (e.g. Turkey, South Africa, Brazil, and Indonesia) will suffer. And how...