Economics - An American tail.

(From Financial Director)

Byline: Dennis Turner, chief economist at HSBC.

Global economic growth accelerated for the third successive year in 2004, with world GDP rising by 4.6%. This was the best year since 2000, and it is tempting to think that international influences on the UK will now be more benign. Far from it. The global economy going into 2005 will constrain activity for several years to come.

The US is at the heart of problem. Since it accounts for one-fifth of global output, it is hardly surprising its influence stretches across all continents. The US led the world economy upward in the second-half of the 1990s and the easing of US growth at the turn of the century sparked a global slowdown. When the Bush administration relaxed both monetary and fiscal policies, it stimulated domestic demand and helped the world economy recover.

That period of expansion has now run its course and the resulting structural problems facing the US economy will have implications for the rest of the world. As he begins his second administration, Bush faces two major economic issues: a $400bn fiscal deficit (3% of GDP) and a balance of payments deficit of $700bn (5.6% of GDP).

On top of this, the personal savings ratio is close to zero, households have a negative financial balance, personal-sector debt is rising and the housing market is overvalued. Strong growth in 2004 raised inflation worries and so the Federal Reserve raised interest rates five times, from a 1% low to 2.25%. With the likelihood of more increases to come (to 3% at least), the debt-servicing costs on an indebted consumer will bite hard, just as the earlier fiscal stimulus wears off. A slowdown in US growth is clearly on the cards, starting in the second-half of 2005 and through to 2006. From almost 4.5% in 2004, the rise in GDP will drop to about 3.3% in 2005 and just over 2% in 2006.

For the rest of the world, the most obvious manifestation of imbalances in the US has been the relentless decline in the dollar. Against sterling, for example, it went from $1.46 in Q4 2001 to $1.92 three years later, while against the euro the fall was from 89 cents to $1.36 in the same period. With the expectation of continued strong US growth in the first-half of 2005, and the increasing cost of servicing foreign creditors who have been funding the deficit up until now, the account deficit is likely to get even bigger, and the dollar even weaker.