America’s recovery since the financial crash has not followed the path it was supposed to. The central bank’s constant dithering over whether to raise interest rates has made it appear weak and unable to influence events.
In the seven years of what, in many economics textbooks, would be considered a strong recovery, the Fed has raised rates just once – by a quarter-percentage point to 0.5%, in December last year.
More than eight million jobs have been created in the US since 2010, and the country’s GDP is now well above its pre-crisis peak – having risen from $14.7 trillion in 2008 to $17.4tn in 2014.
According to its critics, the Fed has set the bar for rate increases too high. Sure, they say, the path of growth has not always been smooth, and indeed the first three months of this year did constitute a weak spot. But, they also say, president Barack Obama’s determination in the years immediately after 2008 to meet the crisis head on – with the most aggressive write-offs of banking sector bad loans in the developed world – set the US economy on a relentless upward trajectory that boosted confidence and investment.
It will come as no surprise, though, should Yellen hold rates yet again on Tuesday. She will say that the generally strong headline growth figures disguise serious weaknesses in the US economy. The combination of turbulent financial markets and an uncertain outlook for the global economy as China slows and Europe contemplates the possible fallout from a Brexit vote, calls for cool heads, and a wait and see approach.
Yellen’s worries can be divided into five main categories.
The US jobs market
The most recent jobs figures appeared to show that employers felt confident about the future. Unemployment benefit claims were low, indicating that redundancies were being shelved in the expectation of more work. Job vacancies were also at a year high. That should be the green light for an interest rate rise. But other signals from the labour market have been flashing red.
We learned recently that only a smattering of new jobs were added in May. This was such a shock that Republican presidential candidate Donald Trump tweeted: “Terrible jobs report just reported. Only 38,000 jobs added. Bombshell!” Economists had expected 160,000 new jobs. That 38,000 total was the weakest monthly rise since 2010.
Sure, the unemployment rate fell to 4.7%, but this seemingly healthy figure reflects the large number of Americans who have dropped out of the jobs market. This has been one of the most marked trends of the past few years – along with the absence of meaningful wage rises.
Last year the participation rate – which measures the proportion of people of working age making themselves available for employment – fell to almost 62%. That was the lowest level since 1977, which was an era of traditional households with a sole (usually male) earner. The rate began rising again late last year and has continued to strengthen in 2016, but remains disturbingly low.
Wage rises have remained sluggish. Take April for instance: Americans’ pay packets actually declined by 0.1% from the previous month, putting the annual gain at just 2.5%. But inflation in the month was a whopping 0.4% – pushing the annual inflation rate up to 1.1%, from 0.9%.
That means that while wage growth in the US is only marginally higher than in the UK, the pay of Americans is being eaten up by an inflation rate almost four times the UK’s 0.3%.
Looking back, it is possible to see that much of the growth in US manufacturing after 2011 was tied to the shale gas boom. The world oil price was high and domestic frackers needed new equipment for drilling and to transport their cheap oil and gas.
The collapse in the oil price from the summer of 2014 signalled the end of the boom. Many fracking business cut back production. Investment in new equipment came to an abrupt end.
Recently, the oil price has clawed its way back from less than $27 a barrel to more than $50, which gave some in the industry a boost – though investment in new equipment is probably some way off.
Chris Williamson, chief economist at financial data provider Markit, said the outlook for manufacturers was also being dampened by the uncertain political outlook, with many businesses wary about making major investments while a Trump presidency remains a possibility.
“US manufacturing is going through its toughest period since the financial crisis,” he said. “The decline of the energy sector, the strong dollar, weak global demand and growing concern about the presidential elections are all playing a part in restricting activity.”
He believes the strong dollar has restricted the ability of car manufacturers to sell abroad and, by making imported goods cheaper, has allowed US consumers to enjoy steady or falling prices – at the expense of domestic manufacturing jobs.
Faced last year with a slowing global economy and a drop in demand for Chinese goods, Beijing relaxed its lending rules and allowed a borrowing splurge to boost growth. The outcome was a bumper March, then a disappointing April. May’s figures could restore calm, but whatever the outcome, there is a bigger worry when it comes to China than yo-yoing economic data – and that is the source of its growth. A record surge in credit in the first quarter came after an already worrying longer-term rise in borrowing, especially in the property sector.
Yellen would be unwise to dismiss concerns over an impending crash in China when President Xi Jinping himself has highlighted the risks of a growing debt mountain.
For now in China, with car sales accelerating and imports showing signs of improvement, domestic demand appears to be picking up and supporting growth. This is part of the rebalancing that Beijing has been attempting to engineer, shifting the economy from heavily indebted state industries to the consumer. The concern is that the consumer will also assume the responsibility for taking on debt to keep the economy afloat.
With the World Bank now anticipating that this year will be marked by the slowest global expansion since the financial crash, China will have to rely on domestic demand to secure Beijing’s goal of growth at between 6.5% and 7% for the year.
Some analysts believe China is heading for a day of reckoning; others put their faith in the powers of the Chinese leadership to write off debts. And if that proves unpalatable, it could exert firm control on the corporate sector and households alike, should things get sticky.
Much of President Obama’s economic effort has been focused on building trade links between the US and the Pacific rim and China.
One of his difficulties has been the rise in the value of the dollar since 2012 – when Europe plumbed the depths of crisis and Japan decided its only route to growth was a dirt-cheap currency that might spur exports.
For a while, growth in global trade offset the higher price of US goods relative to its biggest competitors in Europe and Japan. Then, in 2014, the global economy began to run out of steam. Trade began to wane. Suddenly, highly priced US goods struggled to find a market. Beijing, which suffered an even bigger slowdown in manufacturing output, began doing things like dumping cheap steel on global markets – with dramatic effects in Britain, for one. The US also suffered.
A rise in US interest rates would encourage international investors to buy US assets, and to do this they’d need to exchange their own currency for dollars, increasing the demand for and price of the US currency. A higher dollar would only increase the gap with the euro and the yen and force the Chinese to devalue the yuan, further loosening its ties to the dollar.
But when Beijing devalued last year, it set off a dramatic chain reaction throughout global stock and bond markets, with the result that Yellen found she had to delay a rate rise.
The Federal Reserve has its own research unit, but it probably paid attention to the Organisation for Economic Cooperation and Development’s recent assertion that a British departure from the EU posed as big a threat to the global economy as a “hard landing” in China. The Paris-based thinktank said Brexit would have significant costs not just for the UK and Europe, but for the rest of the world.
Catherine Mann, OECD chief economist, said the uncertainty caused by the referendum had come as the global economy was caught in a low-growth trap. Its analysis predicted that by 2018 the eurozone economy would shrink by one percentage point. Growth for the OECD group of 34 rich countries would be reduced by just over half a point. The UK, which has been one of the few bright spots in the global recovery since 2014, would take an even bigger knock. It would be almost 1.5 percentage points smaller in 2018 after Brexit than if the country voted to stay in the EU on 23 June.
Is this a world that could cope with the destabilising effects of higher borrowing costs in the US? It is to be hoped Yellen will judge it is not.
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