Issue Number 05-1, April 2005
The US Economy In 2004
In evaluating the performance of the U.S. economy in 2004, two important back-ground factors should be kept in mind. The first is that worldwide 2004 was generally a period of considerable growth. China's GDP growth rate was 9.5%, India's 6.6%, Indonesia's 6.7% Argentina's 8.3%, Brazil's 4.9%, and the Euro area's 1.6%. The U.S. rate at 4.4% was higher than Europe's but lower than the emerging economies'.
The second factor is that the U.S. economy had very strong stimulants in place during 2004. Short term interest rates at 1.02 percent in 2003 were the lowest since 1954, actually negative after inflation. In addition, the Federal government ran a fiscal deficit of $380.6 billion, and the U.S. experienced a record inflow of $600 billion capital from abroad.
In assessing the 2004 economy we will consider both the positive aspects and the negative aspects.
Pro: The Production Indicators
As noted, GDP rose 4.4 percent in 2004, which compares favorably with the late nineties and is above the preceding three years. Industrial production at an index of 115.5 exceeded the preceding peak set in 2000. New construction expenditures, which did not decline during the business downturn, set a new record of $998.4 billion. Inflation, as measured by the implicit price deflator for GDP, rose slightly to 108.2 (2000=100), while payroll employment rose 1.5 million. The overall performance of the economy can be gauged in the following table:
The emphasis in this comparison is on yearly change. The 1990s were a period of economic expansion. This expansion led to a record increase in employment and to federal budget surpluses - a sort of nirvana that policy leaders would dearly love to get back to. That requires constant expansion to create new jobs to replace those lost to rising productivity and migration abroad. What we must look for is growth comparable to that in the 1993-2000 period.
The above table breaks down real GDP into its constituent sectors and then includes industrial production and new construction expenditures. In 2003 GDP expansion almost equaled the average for 1993-2000 - $306.5 billion versus $326.3 billion. The item that still lagged was gross private domestic investment, the same item that fell the most in the 2001-2 downturn. The item that exceeded the average of the nineties was government expenditures and investment. The industrial production index in 2003 still fell 0.1 point, while new construction expenditures still lagged the average of the nineties by $3.8 billion.
All this changed in 2004. Real GDP increased $460.3 billion as compared with the average $326.3 billion for the 1990s period. Gross investment led the increase at $214.8 billion, almost twice the nineties' average. Personal consumption expenditures were more than $40 billion higher than either 2003 or the nineties. Negative net exports subtracted more from GDP while government expenditures and investment added more. After slipping in 2003, industrial production picked up at a rate comparable to that in the nineties; the absolute level, however, was almost unchanged from the peak in 2000. But new construction expenditures soared far above either 2003 or the nineties' average. In short, 2004 GDP growth at 4.4 percent was the strongest since 1999.
1 As we noted earlier, these strong production numbers were influenced by growing economies abroad and by economic stimuli at home. Accordingly, we now need to consider these factors.
In this case, we examine various measures affecting demand such as income, debt, and capital flows. After that we examine the consequences of all these developments on employment.
Con: Financial Indicators and Employment
Personal income growth slowed in 2001-2-3 but picked up strongly in 2004, thanks in large part to increased employment. During this same period, taxes on this income fell from $1,237.3 billion in 2001 to $1,038.9 billion in 2004. Income after tax ("disposable") rose $472.5 billion in 2004, but $37.0 billion of it was due to tax cuts, which translate into additional borrowing by the Federal government. Disposable income is the largest determinant of personal consumption expenditures, which as we noted were up very strongly in 2004. Part of these consumption expenditures were, therefore, paid for with borrowed Federal money.
A somewhat similar situation exists with corporate profits. Federal taxes on corporate income were cut just as they were on personal income. The magnitude of these tax cuts may be gauged from the following data:
Almost $200 billion in profits after tax in 2004 was due to lower taxes. Thus, a major part of the profits rise was, again, financed by borrowed money via the Federal government.
Just as personal income is a major factor in personal consumption expenditures, so, too, are corporate profits a major factor in gross private investment. The steep increase in investment in 2004 was spurred in large part by the rise in profits. In this case, however, there is another interesting aspect. Much of the tax stimulus came in the form of immediate 50 percent write-off of new capital investment put into use in the current year. This provision is scheduled to expire in 2005, so that it will completely disappear this year if not extended. Thus, much of the stimulus to gross investment via increased indebtedness of the Federal government may disappear in 2005.
Rising nonfinancial debt has helped propel the economy for decades, but the pace picked up in recent years. In 2000, debt was 206.0 percent of national income, but by 2003 it had risen to 229.9 percent, and by 2004 it was 234.7 percent. This significant increase is apparent in the table. In 2003 and 2004, the yearly increase was more than twice as high as in the 1990s period. Two sectors were responsible for most of this increase, the Federal government and households.
Federal debt grew only $6.9 billion per year during the nineties due to surpluses from 1998 to 2001; since then yearly deficits have ranged from $254.5 billion to $380.6 billion, and these deficits have underwritten much of the increases in disposable personal income and corporate profits that we noted.
Household debt grew $399.7 billion per year in the nineties but jumped to $863.7 billion in 2003 and $1,032.7 billion in 2004. Household debt was 102.0 percent of disposable personal income in 2001, but this rose to 113.1 percent in 2003 and to 118.9 percent in 2004. This increase in debt gave a second boost to personal consumption expenditures since 2001 (the first being lower taxes on personal income). Much of the increase in household debt was due to home mortgage lending, but this still funded the new construction boom, and, since some of it was borrowing for home equity loans, personal consumption as well. Regardless of how this lending was used, it will have to be repaid out of current income. Individuals, unlike the Federal government, do not have almost unlimited credit (and foreign investors to help provide it), so the increased level of indebtedness will not only impinge upon their continued ability to increase consumption but will also threaten the financial solvency of those experiencing misfortune.
Since 1993 the U.S. has experienced a net inflow of foreign capital. In 1993, this inflow was $81.5 billion, but by 2004 it had risen to $615.5 billion. During the nineties the average yearly increase was $55.6 billion, but in 2003 it decreased $24.5 billion, and in 2004 it increased $69.7 billion. The 2004 increase was largely due to foreign central bank purchases of U.S. Treasury securities rather than to normal economic activity. These purchases along with private purchases more than covered the entire federal current deficit. The recent levels have been quite unusual and could change quickly in the future.
Another aspect of U.S. international transactions should be mentioned. The U.S. dollar index as measured against major currencies has fallen from 107.66 in 2001 to 85.36 in 2004, but this decline has not benefited the U.S. trade balance, leading to ever higher external indebtedness. A reversal is clearly called for but could also severely damage the U.S. financial markets. The external deficit along with the federal fiscal budget deficit now equals 8.5 percent of GDP.
Along with financial markets, nonagricultural payroll employment is one of the most sensitive sectors of the economy. Employment peaked in 2001 at 131.8 million and by 2004 was 131.5 million. From January through December 2004 there was a net gain of 2.1 million. The three year decline contrasts with a yearly average increase in the nineties of 3.0 million. This contrast is even more stark when related to GDP and labor force growth as follows:
GDP kept rising from 2001 through 2004 for a net increase of 9.6 percent. Employment for the same period first fell and then recovered for a net decline of 0.2 percent. The civilian labor force, however, rose 2.6 percent.
The employment gains in the nineties were boosted by explosive growth in information processing technology. This growth has now slowed, and some parts of such activity are being moved abroad. The future impact of technological change is as likely to result in job losses as in job gains. With still stagnant jobs growth in goods production, it is difficult to see where major future employment growth will come from.
GDP growth was strong in 2003 and especially 2004. Much of the growth was due to Federal tax cuts that have resulted in record fiscal deficits. Economic growth has not translated into comparable employment growth, while the U.S. international investment position has deteriorated rapidly. The question now is whether growth can be continued without further worsening these negative factors.
The five economies gave a mixed performance in the fourth quarter year over year comparison, with Canada, Germany, and Britain accelerating, and Japan and the U.S. decelerating. Overall, the pace of global GDP growth slowed in the latter part of 2004. Industrial production picked up in all five economies except Britain, where it was unchanged. Japan and Britain remain below the 1997 base. Retail sales fell from a year ago in Germany and Japan while rising strongly in Canada, Britain, and the U.S.
Consumer prices continued to advance at almost a predictable rate except in Japan. In 20 years, prices have more than doubled in Britain and approximately doubled in Canada and the U.S. Unemployment rates edged down slightly except in Germany. Short term interest rates moved up more than a point in Britain and the U.S. but were little changed in Canada and the Euro area. Interestingly, long term rates, which are not controlled by central banks, declined except in Japan. Stock markets responded favorably to economic developments in 2004, with increases in all five markets; the Canadian market was especially strong.
The current account imbalances widened further in 2004. The surpluses of Canada, Germany, and Japan rose to new highs, and the deficits of Britain and the U.S. also rose to new highs. The U.S. deficit equaled 5.7% of GDP whereas in 2002 it equaled 4.5%, a 25% increase in two years. The U.S. dollar continued to depreciate as a result of its deficit, reaching a record of $1.34 against the euro in December. Curiously, the British pound has also risen to a multiyear high against the dollar. The effect of these currency movements is apparent in the commodity price index based on 2000=100. The dollar index for all items on March 15, 2005 was 141.6 whereas the sterling index was 112.1, and the euro index was 98.4. Most commodities are traded in dollars and have risen in price due to high demand. These price increases have been mitigated in Europe by the appreciation of its currencies.
Real GDP grew 4.4 percent in 2004, the strongest since 1999. Industrial production at an index of 115.5 rose above the 2000 high of 115.4, with gains in major categories except mining. The capacity utilization rate of 78.0 was the highest since 2000's 82.0. Manufacturers' new orders at 365.7 billion reached a new high. New construction expenditures by December exceeded an annual rate of more than one trillion dollars, double the level in 1993. However, the number of homes for sale and the vacancy rate for rental housing units are also at new highs. All three of these indicators clearly cannot continue to advance indefinitely.
Real gross investment rose to a new high in 2004 thanks mainly to a surge in nonresidential equipment and software. Business and retail sales also reached new highs. Business inventories were about back to where they were in 2000 before substantial liquidation occurred; retail inventories were well above their 2000 level. Retail sales growth reflected a slightly larger increase in personal consumption expenditures in 2004 than in the preceding two years.
Total employment rose 1.5 million in 2004. Of this total 1.4 million were in services, primarily in the following categories:
Interestingly, "Information" services, the darling of optimists, actually declined 50 thousand in 2004.
Compensation of employees and corporate profits led national income to a larger gain in 2004 than in 2003 or 2002. This resulted in a 2.4 percent increase in real per capita disposable income, the largest yearly increase since 2000. Average real weekly earnings do not reflect these gains, which we interpret to indicate that the income gains were mainly in salaried groups and finance.
Gross and net saving picked up in 2004. Personal saving fell, but business saving rose, and net negative government saving was little changed.
The commodity price index advanced only slightly in 2004, and despite the hype about the rise in these prices, it is well to remember that they are still below the 1995 base. Metals and oil have led the advance. Producer prices actually declined in 2002, but the index rose about five points in 2003 and 2004. Consumer foods and nondurables have been the strongest groups.
Corporate profits rose approximately 150 billion in 2003 and 2004, primarily in the domestic nonfinancial sector. The ten year Treasury yield rose only about one quarter percent in 2004 and slightly more than that in the first quarter of 2005. During 2004 the federal funds rate rose about 1.16 percent. So far, the bond market has not followed Federal Reserve moves upward.
The M-3 money supply rose 6.2 percent while nonfinancial debt rose 8.6 percent; prior to 2002, money growth had exceeded debt growth. The Federal deficit grew only slightly from 2003 to 2004.
Bank credit growth accelerated in 2004, primarily for real estate loans. Consumer credit also grew but was well below the years prior to 2002.
Nonfinancial debt growth of 8.6 percent was a little higher than in 2003. Federal debt grew 9.0 percent while household debt grew 11.0 percent. Financial debt growth of 7.2 percent was the lowest since 1991.
Total bankruptcy filings were down from 2003.
The U.S. negative balance on goods and services rose $120.6 billion to -$617.1 billion, 5.3% of GDP; in 2002 it was 4.0%. Both exports and imports increased considerably, but the increase in imports was almost double the increase in exports. Imports of services grew slightly more than exports, but the balance is still positive. These changes are particularly interesting in view of the continuing decline of the dollar against most major currencies.
Capital flows into and out of the U.S. picked up significantly in 2004. Inflows grew more than outflows, resulting in a net negative change well exceeding one half trillion dollars in the U.S. net investment position.
Foreign purchases of Treasury securities in 2004 were over twice as high as in 2002. Of the $369.7 billion Treasuries purchased, $261.5 billion were official foreign central bank purchases for currency support and accumulation of foreign reserve purposes. The total $369.7 billion purchased equaled 97.1% of the Federal government fiscal deficit! Foreign purchases of other U.S. securities also rose strongly in 2004.
Copyright © Andrew Caughey, 2005
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