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American Economy: on the rise, no need to panic

Bhuwan Thapaliya - 2/6/2007

An Economist, it has been said, is an expert who will know tomorrow why the things he predicted yesterday did not happen today. This is true of Gross Domestic Product (GDP) forecasting too.

Over the past several months economists have repeatedly forecasted that the American economy would falter or perhaps land in recession, and the growth rate would stand nowhere near against the other major economics of the world. They have been wrong.

“On Wednesday, January 31st, new figures for the last quarter of last year showed the economy grew at a stronger than expected annual pace of 3.5%,” according to the Economist.

That is way higher than what most economists expected. As ever the economics profession has minted many explanations for this growth. But America’s latest recovery has been credited, among other things, on housing bubble, as most analysts have viewed the American economy as largely supported by rising house prices.

Soaring house sales has boosted the American economy, and fortunately for America, the sales of new homes are surprisingly strong, way beyond the initial expectations.

“Consensus estimates had predicted a rise of a little over 1.2% for these in December; instead, they surged by almost 5%, after a healthy rise in November. Although existing home sales are still weakening?the latest data show a fall of 0.8% in December, but even as prices have fallen, consumer confidence has bounded along at its highest level for five years,” says a report published by the Economist.

Part of growth has been led by the construction market and the other half of the growth has been led by a significant shift in consumer perceptions of the job market.

Though the unemployment rate is low, but American economy in recent times is plagued with shrinking labor-force participation and stagnant real wages. But fortunately, according to the reports, both hourly and weekly earnings started to rise in the second half of last year. And this is an encouraging sign, and a sign of the labor market revival, vital cog necessary for the robust growth of any economy.

In particular, some of the structural conditions that have plagued the labor market may be improving. So it is more than just possible that workers appetites for dollar assets may inflate further.

The economy also appears to be creating jobs more quickly today. More and more workers are looking for jobs and they are getting it too. And the consumers are less hit by the inflation than they were because of the declining energy prices. For instance, oil is trading at around $56 a barrel, and petrol prices are flirting with $2 a gallon.

But at this juncture, not all these indices makes fed chief, Mr. Bernanke’s job easy as these rosy economic indicators could easily become thorny as many still fear the housing market and the depreciating dollar.

There are other dangers too. After all, the dollar no longer fulfils the classic function of an international reserve currency. It is no longer a reliable store of wealth.

And there is always this fear: what if some OPEC members push oil prices up again? Traditionally, this means rise in inflation leading to financial instability.

America was the world’s biggest creditor until the 1980s. But it is now the world’s biggest debtor and so likelier to succumb to the temptation to let inflation nibble away at the real value of its debt, or to devalue in order to narrow its trade deficit.

This makes it even more important than ever that American policy maker pursue sound fiscal and monetary policies.

In particular, they cannot afford to take a relaxed attitude towards the construction market propelled economy. Given America’s more advanced position in the economic cycle, this suggests that the Fed’s monetary policy is probably still too lax though it has been able to keep interest rates unchanged.