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RECENT DEVELOPMENTS HAVE reminded us again of the outsized impact the US has on Asian economies and markets. President Barack Obama’s trip to India, Indonesia and South Korea, the US Federal Reserve’s decision to step up quantitative easing and the electoral setbacks that Obama’s Democrat party suffered recently have all dominated the headlines. Will the US be a positive factor for Asia or otherwise?
In a nutshell, our view is that the American economy is slowly gaining traction, but the pace of improvement is inadequate to ward off political and economic risks that could still hurt Asia in the coming year.
US economy: Multiple challenges, no quick return to dynamism
The US economy is not just coping with the aftermath of the 2008 financial crisis. American political leaders, businesses and workers are also confronting the challenge of resolving longstanding structural problems that they had avoided in the good years. Structural weaknesses, such as the fiscal system, raising household savings and improving export competitiveness, were put aside. Now, with the bubble economy no longer artificially boosting spending and jobs, the US finds that it has no choice but to make these hard adjustments.
Unfortunately, all this restructuring hurts economic activity in the short term — shedding jobs, allowing uncompetitive activities to wither away while taking the risk of investing in new industries, squeezing suppliers to improve pricing and quality and shutting down underperforming business lines. It is in the context of these multiple challenges that we have to assess recent developments in the US.
The good news is that the US economy is making some progress.
First, the competitiveness of US businesses is improving. It is not just that the US dollar has weakened in trade-weighted terms. There has been a material fall of about 7.5% in the manufacturing sector’s unit labour costs in the past year, as productivity growth has been ramped up. Together with the roughly 8% fall in the US dollar’s real trade-weighted value, the US economy has improved its competitiveness hugely. This will help boost exports — and, more importantly, domestic businesses will find it easier to displace imports in the home market as well.
Second, US businesses have been investing in new equipment as part of this restructuring. Spending on core capital goods is now about 30% higher than in the recessionary trough of April 2009. The latest data on durable goods orders and small business optimism (improving again) suggests that investment will continue to support economic growth. Of course, as more equipment is purchased, eventually businesses will have to step up hiring as well.
Third, the credit constraint on business expansion could improve over time. The Fed’s recent survey of loan officers suggests that lending standards are now beginning to ease, reinforcing the improvement shown in the previous survey.
Fourth, the household savings rate has improved. Although volatile and still not high enough, the savings rate has bounced from virtually zero during the height of the bubble economy to 5.3% now. The savings rate still needs to rise further if the US economy is to achieve re-balancing, but the hardest part of this painful adjustment has been made.
This is good progress and it is important for the longer term. The problem is that such improvements are not enough to keep the economy firmly on a healthy growth track over the next year, given the continuing headwinds in the economy:
- The fiscal stimulus will rapidly turn into fiscal drag in the coming year. It is not just the massive 2009 stimulus that has to be unwound. It is years of irresponsible political management of the budget deficit that have to be rectified. The Social Security Fund will go into deficit soon. This was foreshadowed a long time ago, but the political elite chose to put off hard decisions — just as it avoided unpleasant decisions on tax reforms such as a value-added tax and an energy tax.
- The restructuring described above will restrain the recovery in consumer spending. Employment will probably continue to improve, but the overall unemployment rate will remain high and this will limit wage growth. Household income will therefore not grow very strongly and consumer spending will remain weak.
- Neither is the housing sector showing signs of a recovery sufficient to give consumers the confidence and wealth effect to spend. While there have been some signs of improvement — in home builders’ confidence, new home sales, housing starts — these are off an extremely low base. What improvement there has been seems to have been dependent on government support schemes, which are now expiring. In reality, the housing sector will remain a drag on US growth for some time to come.
The bottom line: At best, the US economy will plod along, with periods of growth followed by periods of stagnation in the next two years. Asians will see some growth in US demand, but it will not be much. In the meantime, a plodding economy will require ever more monetary stimulus — which will mean more flows of speculative capital into Asia.
It is US politics that Asians will have to worry about most
US political developments will hurt Asia. The mid-term elections for Congress were a disaster for Obama’s Democrat allies, who lost control of the lower house, the House of Representatives, while their majority in the upper house, the Senate, fell sharply. Moreover, the Democrats’ control over state legislatures and governorships has also diminished — allowing their Republican opponents to drive the re-demarcation of electoral boundaries in a way that could entrench Republicans in key states.
Some commentators have argued that Obama will replicate former President Bill Clinton’s tactics when confronted with a similar mid-term electoral disaster in 1994: Clinton out-manoeuvred a Republican congressional leadership that overplayed its hand and went on to win a convincing re-election in 1996. Obama will not have it so easy this time. The Republicans will not repeat their tactical mistakes of the 1990s and Obama will not have the benefit of a strong economy to support his popularity, as Clinton did. For his Republican opponents, the calculus is clear: The real prize for them is to re-take the presidency in 2012. To achieve that, they gain more from obstructing Obama and showing him to be a weak president than by compromising with him in such a way that he is able to tell voters that he can deliver the goods. There are three things that could hurt Asia.
First, Obama now has to think hard about his re-election campaign — the first of the presidential primaries is just over a year away. He has to re-assert leadership strongly so as to deter any challenge in the Democrat primaries that could weaken him in the main presidential election. Since time is short and his position in Congress is weak, he has to come up with quick wins. The temptation to push through populist policies to bash foreigners must therefore be quite strong. Notwithstanding all the goodwill generated by his recent trip to Asia, China specifically and Asia generally will be in the firing line.
Second, there does not seem to be common ground for compromises to resolve the US’ fiscal and financial mess. That means the US will remain vulnerable to financial stresses and possibly even another financial crisis at some point. For example, without a credible plan for fiscal consolidation, the risks of a gradual depreciation of the US dollar turning into a rout will rise.
Third, geopolitical risks may also rise if the strategic rivals of the US — Russia and China on the global level and North Korea, Iran, Syria, Venezuela and Sudan at the regional level — try to take advantage of the US’ weakness to push ahead with destabilising initiatives of their own. That would make for a more dangerous world for Asia.
Putting it altogether, the US will remain a source of growth for Asia, but its importance will decline over time. However, the impact from the financial and political developments in the US could well be less benign.
