Current conditions show weakening economic growth and labor market. After the slowest initial recovery in postwar history, the economy took off briefly in mid-2003; since then, however, the expansion has generally decelerated. Growth is slowing, because the job market remains weak, real wages and incomes continue to fall, and energy prices have risen sharply. The worst trade and current account deficits in U.S. history also threaten a potential dollar crisis that would drive up interest rates and further slow the economy. With the United States and China weakening, another sustained jump in oil prices could trigger a global downturn in 2005.
- The U.S. expansion slowed to a 2.8 percent annual rate in the second quarter, a sharp downshift from the 4.5 percent pace in the first quarter and a 6.2 growth rate for the second half of last year.
- Last year's spurt of strong growth was based not on the economy's own strengths, but mainly on the short term effects of the July 2003 cuts in income taxes and interest rates.
- The poor performance of the job market since 2001 largely precludes the strong, self-sustaining growth of the 1990s: Job losses in the 2001 recession, relative to the decline in GDP, were three times greater than in previous downturns; and the job gains in this recovery have been the slowest on record.
- The slow job market has driven down real wages for three consecutive years, despite the stimulus of record-high deficits and record-low interest rates.
- With real incomes still falling, this year's 35 percent jump in energy prices will continue to weaken consumer spending, the main driver of U.S. growth.
- Looking ahead, growth is likely to slow further in the second half of this year and into 2005:
- Energy prices will likely remain high: Demand will increase with colder weather, and the supply problems in Russia, Iraq, Venezuela and Nigeria are expected to persist;
- U.S. businesses, facing intense global competition and fast-rising costs for energy and health care, will continue to create jobs at less than half the rate of previous recoveries;
- Until strong job creation is restored, pressures on real wages will persist;
- With wages falling, household debt at record levels, and family bills for energy, health care and debt service all rising, Americans are cutting back on other spending, weakening the expansion.
The United States is not in danger of slipping into a recession. Even as consumers cut back, business investment will sustain a modest expansion in the second half of this year: Record profits will provide the means for this capital spending, historically low inventory-to-sales ratios provide the demand, and investment tax benefits set to expire on Dec= 31 will spur the timing. Housing investment also should remain healthy in the second half as the economy's overall softness helps keep mortgage rates low.
Foreign factors could produce more serious problems next year. Our trade and current account deficits already top the levels which in 1987 triggered a dollar crisis and sharp drops in U.S. and global stock markets, and our imbalances are unlikely to improve. The United States absorbs more than 80 percent of worldwide saving to fund the current account, mostly from Asia; if an economic slowdown in Asia cuts into those savings, it will weaken the dollar and force up U.S. interest rates. Should this occur while China's slowdown deepens, and oil prices remain high, it could mean a global downturn in 2005.