One of the most unprecedented shocks to our economic system has been met with an equally extraordinary response by governments and central banks around the world. Slashing interest rates to near zero; experimental quantitative easing programs; huge bank bail-outs and unparalleled fiscal stimulus programs have culminated in a dramatic shift in fundamentals.
In the US, citizens are dedicated consumers (70 per-cent of national output is generated from consumption). US households have been able to establish a negative savings rate in the recent years and therefore, unsurprisingly, have one of the highest debt levels in the world. By mid-2008, US households were in debt to the tune of $14.5 trillion, representing 134 per-cent of disposable personal income.
However the US has reached a turning point. Higher debt enabled personal consumption expenditures to grow faster than disposable income, providing a significant boost to US economic growth over the period. Such a trend cannot be sustained in the long run and it has now gone into a dramatic reversal. But how will the global economy cope as the most leveraged economy in history attempts to de-leverage?
Household debt decreased for the first time since 1952 this year. This in turn resulted in a rise in the savings rate. From a level of 10 per-cent in the 1980s, it has been declining ever since, and is now expected to reach 3-5% this year.
Debt can cripple an economy, and so a shift away from borrowing toward savings should, in theory, boost the growth potential for the US. But the irony is that a move away from borrowing at a time when the US economy is so fragile only cripples domestic demand further and threatens to prolong the economic downturn.
Seeing consumption buckle under the pressure of debt, the US government intervened in ways previously unimaginable. In February this year congress approved a $787.2 billion economic stimulus plan. One of the many facets of this plan was the CARS (“Cash for Clunkers”) program that offered a generous rebate for trading in older, less environmentally-friendly autos. Accounting for $3 billion of the stimulus program’s funding, it was almost a complete failure. Auto sales were temporarily boosted in July and August by the program only to crash to pre-existing levels once the stimulus money dried up. Not only did it fail to ignite a stable demand, it also failed to create jobs. Any recovery needs to be built on job creation, not temporary and unsustainable stimulus measures.
The problem with such large scale government intervention is that when it is removed, the same problems resurface because the fundamental imbalances have not been adjusted. For example, sales of existing homes surged by 9.4% in September as buyers raced to take advantage of the tax credit for first-time home buyers before it expires next month. While many analysts are calling a bottom in the market, the home buyer tax credit of up to $8,000 is set to expire November 30, and efforts in Congress to extend it are uncertain. Regardless of whether or not such measures are extended, once they are removed there will be little appeal for buyers to enter the property market.
The US economy had been overheated for some time and so a correction was all but inevitable. However, instead of reflecting upon the deep-seated inequity that culminated in the worst economic downturn since the great depression, the US has refused to take the necessary medicine, and this is taking its toll on national debt, which is set to hit over 100% of national output by 2011.
The British government, too, have been quick to embrace this trend pledging $47 billion to revive the economy in November last year. However, almost one year on the UK still finds itself lingering in recession. The 0.4% drop in Gross Domestic Product in the third quarter was a far cry from the consensus forecast of a 0.2% rise, let alone the even stronger rises suggested by surveys. According to Capital Economics’ UK Analyst Vicky Redwood: “The fact that the economy is still contracting despite the huge amount of policy stimulus supports our view that the recovery will be a long, slow process.”
For Ireland, the failure of these economies to adequately adjust to the downturn could be detrimental to future growth.
Its economy is irrefutably linked with that of the US and UK. Over 20% of Ireland’s exports are to the UK alone and US multi-nationals have been the main driving force behind the Irish growth success over the past 15 years. Furthermore, despite the recurrent policies aimed at integrating Ireland with other European economies, Irish consumers have more in common with their Anglo-Saxon counterparts than those in mainland Europe. Indeed, the Irish savings rate accelerated from 3% to 10% since 2007 and household debt has fallen by an estimated 13.7% over the same period. This is a stark reminder of how intertwined the economy is with the US and UK.
Ireland faces a unique challenge. Given the pressure on public finances and the collapse in consumer spending, the economy has had to look elsewhere for direction. Luckily it has come in the form of “E”, or exports. Despite tough global conditions and a strong Euro, exports have proven to be the one beacon of light for the Irish economy in this downturn. The cumulative trade surplus so far this year totalled €26,693 million – 52.2% higher than for the corresponding period in 2008. Commenting on the latest trade figures, Bloxham Stockbrokers’ Chief Economist Alan McQuaid said: “The bottom line is that exports will be the main driver of the Irish economic recovery when it comes.”
While the Irish economy is still heavily entrenched in recession, the prescription for growth may yet prove to be effective. Export driven growth is inherently more stable than propping up an economy using debt. The lessons of the 1980s have not been forgotten, but they have yet to be taught to our neighbours on either side of the pond.