Poor US Economy and Future Prospects
The Agency officially announced that the US economy is sick, and sick seriously.
The last month was not good for already stumbling US economy that received another blow from the leading credit rating agency Standard and Poor (S&P) which down-graded its credit rating from AAA to AA+. The S&P almost first time since its existence lowered long-term outlook on the sovereign U.S. debt to the downside, from stable to negative. This means that the position of the world's major currencies - the dollar - is much reduced. Although US government was able to pass a new act that increased the debt ceiling (amount of money the country could borrow), poor economic growth numbers have raised the prospects of another recession in the world's largest economy. The S&P dropped the United States rating one level over concerns that the country's plan to lower deficits does not go far enough. The Agency officially announced that the US economy is sick, and sick seriously. The credit rating downgrade stemmed not only from runaway US deficits and national debt, but also the expectation that America's debt burden will grow heavier in the future. The Managing Director of S&P, in an interview, pointed to Washington's inability to overcome political obstacles and enact aggressive fiscal reforms. S&P lists 5 pillars in its Sovereign Rating Framework as:
The S&P downgrade further fueled these speculations and came at a time when most analysts were busily revising down their growth estimates and talking about the recession.
Institutional effectiveness and political risks, reflected in the political score Economic structure and growth prospects, reflected in the economic score
External liquidity and international investment position, reflected in the external score
Fiscal performance and flexibility, as well as debt burden, reflected in the fiscal score
Monetary flexibility, reflected in the monetary score
(Source: Standard & Poor's Sovereign Rating Framework)
Economists were worried about the possibility of a stalling US economic recovery even before the S&P downgrade. Many reports point towards slowing down of the economy. For example, the Commerce Department's report announced expansion of US economy at an annual rate of 1.3 percent during the second quarter of the year which is pretty low by all standards. The S&P downgrade further fueled these speculations and came at a time when most analysts were busily revising down their growth estimates and talking about the recession. This is a further hit to business confidence and to household confidence. The critics of President Barak Obama term Standard & Poor's rating downgrade as a deeply troubling indicator of America's decline under President Obama. They blamed that his failed policies have led to high unemployment, skyrocketing deficits, and now, the unprecedented loss of nation's prized AAA credit rating.
The downgrading of credit rating of developed economies is not something new. In the past many countries received such downgrades. But with a solid reform program, they were able to pull out of such situation. Five countries, including Canada, Sweden and Australia, managed to regain their AAA rating after falling to AA+, as the United States did last month. But the quickest rating recovery took nine years to materialize, and came after enacting significant reforms to improve finances and boost economic output. The trouble for United States economy is that it has yet to demonstrate the capacity and commitment to change. Given the nature of the debate in the country and the polarization of views around fiscal policy, the S&P indicated that they do not see anything immediately on the horizon that would help an upgrade back to AAA again. The S&P downgrade is not really about the ability of the U.S. to meet its debt payments, it is about the ability of its policymakers to get their arms around the problems, and put the country back on the path of growth, jobs, and prosperity. And until they do that, the United States risk further downgrades.
The S&P report on down grading of US economy has profound psychological and economic effects for the world economy. It sent shock wave to the global economy, as a result, panic ran among global investors and they rushed to get out of risky assets like stocks. In just three weeks (from July 26 through Aug.11) about $6.8 trillion was wiped off the value of global equity markets. This news also did not go well because of America as the biggest debtor. China, Japan and Russia hold U.S. debt in their reserves as part of a financial portfolio. China holds more than one trillion dollar, Japan nearly 900 billion, while Russia holds over $ 150 billion. Total American government owed to its creditors over $ 14 trillion is nearly 100 percent of gross domestic product (GDP). The budget deficit has too long exceeded the rate of 3 per cent for countries with the highest rating, such as Germany and France, for example. In this new situation, investors are going to have to get accustomed to above- normal volatility. Economic uncertainty is going to continue to outweigh the good. The large price swings are indicative of uncertainty in the markets.
It is pertinent to note that the United States has the largest, most diverse and technologically advanced economy in the world. The population of US accounts for only about 4 percent of the world's population but its GDP is 26 percent of the world's total economic output. It is based on the private enterprise system that has only limited government intervention in areas such as health care, transportation, and retirement.
American companies are among the most productive and competitive in the world. In 1998, 9 of the 10 most profitable companies in the world were American (even the non-U.S. exception, Germany's Daimler-Chrysler, has a substantial part of its operations in the United States). Unlike their Japanese or Western European counterparts, American corporations have considerable freedom of operation and little government control over issues of product development, plant openings or closures, and employment. The United States also has a clear edge over the rest of the world in many high-tech industries, including computers, medical care, aerospace, and military equipment.
The United States has considerable natural resources. These resources include coal, copper, lead, phosphates, uranium, bauxite, gold, iron, mercury, nickel, silver, tungsten, zinc, petroleum, natural gas, and timber. It also has highly productive agricultural resources and is the world's largest food producer. The economy is bolstered by an excellent, though aging, infrastructure which makes the transport of goods relatively easy.
In the 1990s, the American economy experienced the second-longest period of growth in the nation's history. The economy grew at an average rate of 3-4 percent per year and unemployment fell below 5 percent. In addition, there were dramatic gains in the stock market and many of the nation's largest companies had record profits. Finally, a record number of Americans owned their own homes. This long period of growth ended in 2001, when the economy slowed dramatically following a crash in the high-technology sector.
Despite its impressive advantages, the American economy faces a number of problems. Most of the products and services of the nation are consumed internally, but the economy cannot produce enough goods to keep up with consumer demand. As a result, for several decades the United States has imported far more products than it exports. This trade deficit exists entirely in manufactured goods. The United States actually has trade surpluses in agriculture and services. When adjusted for the surpluses, the U.S. trade deficit in 2000 amounted to a record $447 billion. The United States has been able to sustain trade deficits year after year because foreign individuals and companies remain willing to invest in the United States. In 2000, there was $270 billion in new foreign investment in
American companies and businesses.
Another major problem for the American economy is the income inequality, with some Americans enjoying very high income levels while others remain in poverty. As the workplace becomes more technologically sophisticated, unskilled workers find themselves trapped in minimum wage or menial jobs. In 1999, despite the strong economic growth of the 1990s, 12.7 percent of Americans lived below the poverty line. There are other wage problems in the United States. Although the economy has grown substantially, most of the gains in income have gone to the top 20 percent of households. The top 10 percent of households earned 28.5 percent of the nation's wealth, while the bottom 10 percent accounted for only 1.5 percent. There is also a growing number of Americans who are not covered by medical insurance.
Although American economy has diversity, services dominate economic activity and accounts for approximately 80 percent of the country's GDP. On the other hand, manufacturing accounts for only 18 percent, while agriculture accounts for 2 percent. Financial services, health care, and information technology are among the fastest growing areas of the service sector. Although industry has declined steeply from its height in the 1950s, the American manufacturing sector remains strong. Two of the largest American corporations, General Electric and General Motors, have manufacturing and production as their base, although they have both diversified into the service sector as well. Meanwhile, despite continuing declines, agriculture remains strong in the United States. One of the main trends in the agricultural sector has been the erosion of the family farm and its replacement by the large corporate farm. This has made the sector more productive, although there has also been a decrease in the number of farmers and farm workers.
Since the middle of the 20th century, the United States has aggressively pursued free and open trade. It helped found a number of international organizations whose purpose is to promote free trade, including the General Agreement on Tariffs and Trade (GATT), now known as the World Trade Organization (WTO). It has also engaged in free trade agreements with particular nations. The North American Free Trade Agreement (NAFTA) between the United States, Canada, and Mexico is an example of this. One continuing problem for American companies engaged in foreign trade is that the United States is much more open to trade than many other nations. As a result, it is easy for foreign companies to sell their goods and services in the United States, but American firms often find it difficult to export their products to other countries.
The trouble for United States economy is that it has yet to demonstrate the capacity and commitment to change.
The nation is a net provider of economic aid. It provides $6.9 billion in direct aid to nations. In addition, the United States funds many international organizations. It provides 25 percent of the operating budget of the United Nations and almost 50 percent of the budget for day-today NATO (The North Atlantic Treaty Organization is a military alliance of 19 countries in Europe and North America) operations. Nonetheless, this aid has only a small impact on the U.S. budget. All spending on international affairs, including the costs of maintaining embassies overseas, foreign aid, and support for international organizations, amounted to $19.5 billion in 1999. That was only 0.01 percent of the federal budget. In comparison, in 1999 the United States spent $26.7 billion to fund the Central Intelligence Agency (CIA).
None of this will help the U.S. standing in the world if the American government is not going to introduce reforms. Already, outside commentators have seen the U.S. debt and the political system's clumsy handling of it as proof of American decline. A debt deal that extends the fraught politics over deficit cuts through the end of this year is likely to keep this painful issue in the headlines. Also, the borrowing authority that the president has been granted will keep the government running only until 2013. In less than two years, this fight will resume again.
(Source: Newspapers and internet)
Dr Zafar Mueen Nasir