Calm before the Storm

Article excerpt

Garten is dean of the Yale School of Management.

The global growth engine is finally moving into high gear. Driven by the United States, fueled by soaring demand in China and boosted by reform in Germany, France and Japan, the world seems poised for expansion in all its major economies. The next four to eight months look very promising, according to forecasters just about everywhere.

Yet an undercurrent of worry remains. In the past two years, the rare simultaneous downturn in all the major economies produced uncertainties that still haunt the recovery. For different reasons--overheating in China, rising deficits in the United States, runaway spending in Europe--there is a strong possibility that central banks will be compelled to raise interest rates and choke the recovery. While emerging markets are enjoying a stock-market boom, it is driven largely by a perceived shortage of opportunity in major markets, and could quickly dissolve in capital flight. Threatening everything are political tensions among the major countries over issues ranging from terror to trade and currencies. No major country is content with the value of its currency, and there is no mechanism to satisfy them all--a situation that could easily lead to crisis in 2004. So my New Year's message is: enjoy the moment, but be skeptical about rosy long-term projections.

The United States: There is lots of good news--8.1 percent growth in the last quarter, the highest levels of productivity in 20 years, expansion of manufacturing, an unemployment rate that has declined from 6.4 to 5.9 percent. Corporate profits have soared, business investment is beginning to revive and the Dow has risen to pierce the symbolic 10,000 mark on more than one occasion. All this is happening with low levels of inflation, too. The Organization for Economic Cooperation and Development (OECD) projects U.S. GDP growth in 2004 of 4.2 percent, compared to 2 percent this year, and some forecasters are even more optimistic.

There is no mystery why this recovery has occurred. The economy is inundated by stimuli--the lowest interest rates in 40 years, the largest tax cuts in memory and consumers who just can't stop buying big-ticket items. Companies have streamlined for fierce competition. Nevertheless, in pushing massive new tax cuts combined with big spending hikes on everything from military readiness to health insurance for seniors, Washington has almost guaranteed unprecedented fiscal deficits for many years to come. Goldman Sachs sees this red ink going as high as $500 billion next year, a 20 percent increase over the unprecedented 2003 levels. At the same time, Uncle Sam has been running trade deficits so large that it needs to borrow about $2 billion per day from foreign lenders. HSBC, the global bank, says that amount could easily double in a few years. The single biggest danger to the U.S. recovery is that these two deficits will drive up interest rates and thereby choke off growth.

There is a good chance rate hikes will come by the end of 2004, when a number of factors could converge. Economic growth will be strong. President Bush will be making new spending commitments to assure his re-election. In this situation, the Federal Reserve could move to tighten credit to ward off the specter of inflation, or the bond markets could act on inflation fears and drive up long-term rates. Economic activity abroad will be picking up, too, and overseas investors may redirect funds away from the United States--or at least demand higher interest rates from American borrowers.

China: Asia is likely to generate more than half the growth in global trade this year, and China will account for most of that. U.S. sales to China have been growing at more than 20 percent per year. Two thirds of Japan's exports now go to the People's Republic. Beijing's soaring demand has forced up global prices for everything from beef to oil to shipping rates. Truth is, no nation has ever sustained such extraordinary growth for so long, and China is due for a setback. …