Slower Growth Likely in 2005

By Mark Weisbrot

This article was published in the following news outlets:

Knight-Ridder/Tribune Information Services - February 2, 2005
Duluth News-Tribune (MN) -  February 5, 2005
Milwaukee Journal-Sentinel - February 6, 2005
Pueblo Chieftain and Star-Journal (CO) - February 6, 2005
Panama News Online  - Feb/March 2005 issue

For all the perennial optimists who were hoping that this year would bring better economic times than the last, hope is not going to be enough. Which is too bad, because last year wasn't all that great for most Americans.

It's true that our economy (Gross Domestic Product or GDP) grew by 4.4 percent last year, which is the best growth performance for five years. But unfortunately these gains did not trickle down to the majority of our hard-working population. Real wages -- that is, what your wages can buy -- actually fell over the year.

That this is not a well-known fact is an indication of how little the interests of most Americans are taken into account, in national economic news reporting and political discussion. Throughout most of American history, the majority of the labor force did indeed share in the gains from economic growth.

Our economy gained about 2.2 million jobs last year. This is similar to the 2.1 million annual average for the nineties -- but not very good for a year that followed three years of actual job losses.

The only thing worse than not sharing in the gains from growth is having even less growth to share. If the economy were able to keep growing at last year's pace, real wages would eventually rise. But alas this growth is not in the cards. The fourth quarter of last year saw only 3.1 percent growth. Before this figure was reported last month, economists were forecasting about 3.5 percent growth for 2005; these forecasts will now be revised downward.

But all this assumes that we are lucky. It is almost an axiom that if a rock sits long enough on the edge of a cliff, it will eventually fall over the edge. We have a big bubble in housing prices in the United States. We know this because house prices have risen by more than 40 percentage points beyond the rate of overall inflation since 1995.

This has never happened before, and there is no plausible explanation other than a speculative bubble. When this bubble breaks it will most likely cause a recession, just as the bursting of the stock market bubble in 2000-2002 triggered our last recession.

One thing that could burst the bubble would be a rise in long-term interest rates. These determine mortgage rates and are extremely low right now. The yield on 10-year Treasury notes is currently 4.2 percent, which adjusted for inflation is about 0.9 percent. Historically this real (inflation-adjusted) rate has been closer to 3 percent.

How long can these unusually low rates be maintained? The answer seems presently in the hands of Asian central banks, especially Japan and China, who are gobbling up U.S. bonds, not because these bonds are a good investment, but because they consider it in their interest to support the U.S. economy. We are running an unsustainable trade deficit, borrowing more than 6 percent of GDP from abroad. Our creditors will eventually lose some of their appetite for dollars -- but when?

Maybe all these big rocks will sit on the cliff for another year. But there are other reasons for pessimism. The most important source of demand since the 2001 recession came from homeowners who borrowed literally trillions of dollars when they refinanced their homes. That episode has about run its course, as have the tax cuts. Consumers are now buried under record levels of debt, with a savings rate near zero. The Fed has raised interest rates six times in the last seven months and will likely continue to do so every six weeks. All this makes it even more likely that last year will look good compared to 2005.