Economists are predicting great things for 2004. But beneath the rosy forecasts lie some disturbing trends.
Experts are calling for the economy to grow 4.2% next year, thanks to a rise in business investment and a further increase in consumer spending, according to a survey by Blue Chip Economic Indicators, an economic forecasting group. If so, it will be the fastest pace in five years, and well ahead of the 2.9% forecast for 2003, despite an 8.2% surge in gross domestic product during the third quarter.
"I think the U.S. economy is very resilient," said Anirvan Banerji, director of research at the Economic Cycle Research Institute. "Even an unexpected shock is unlikely to derail this recovery."
Optimism aside, Banerji believes the recovery will be "lopsided," with some sectors performing well and others continuing to struggle. "The structural shift in the economy is ongoing," he said. "There is continued deflation in finished goods and a continued need to outsource jobs to Eastern Europe and India."
The manufacturing sector has been hit hard by deflationary pressures in manufactured goods, and some 2.5 million jobs have been lost since January 2001. Banerji said more factory workers will be laid off in 2004, even as the economy improves. While jobs will be created elsewhere, he said employment growth "is unlikely to be commensurate with the kind of robust GDP growth we've seen."
Since the beginning of the last recession in March 2001, almost 2.4 million jobs have been lost, making this the worst job crisis since the Great Depression, and despite signs of improvement recently, the labor market is far weaker today than it was at this point in previous recoveries.
This is particularly worrying for consumers, who already are heavily indebted and worried about job security. Mortgage balances have surged this year and household debt-to-net-worth ratios are currently sitting close to all-time highs. Many economists say they expect spending to slow going forward because consumers are so highly leveraged and there's little, if any, pent-up demand.
At the start of previous expansions, spending ramped up nicely as consumers gradually loosened their purse strings. Today, consumers are just emerging from a massive spending binge brought about by low interest rates. As the mortgage refinancing boom comes to an end and tax cuts from the government start to fade out, pundits say consumers will have fewer incentives and far less disposable income.
"We think the story of 2004 is spending rising somewhat slower than income," said William Dudley, director of economic research at Goldman Sachs. "Income should also slow down because there'll be less fiscal stimulus."
While a rise in business investment could mitigate some of the damage from a slowdown in consumer spending, economists say capacity utilization rates remain low, meaning that some firms will remain reluctant to spend money on new plants and equipment.
Other experts worry about the dollar, which has fallen 13% this year, and is likely to decline further next year.
A weaker dollar can be good for corporate earnings, but it also can provide foreign investors with an excuse to take money out of U.S. assets. A sagging dollar reduces the attraction of stocks and bonds to foreigners and can lead to higher inflation, which in turn means tighter monetary policy.
Stephen Roach, chief economist at Morgan Stanley, is concerned about a related issue: the huge rise in the current account deficit. He is looking for 4.7% growth in the U.S. next year, but he believes a significant portion of that growth will come at the expense of gains in 2005.
"While the recent momentum in the global economy is encouraging on the surface, the fundamental tensions of an unbalanced world are deepening," he said in a recent note.
Roach has long been concerned that America is living beyond its means, and that the rest of the world has become much too dependent on the U.S.
In past downturns, the current account deficit, which is the difference between what the U.S. borrows from foreigners and what it sells to them, narrowed. But this time it has grown to around 5% of GDP. The U.S. must now attract around $1.5 billion each day to finance this deficit.
"We're using that to buy more and bigger SUVs, more McMansions and more and bigger federal spending programs," said Paul Kasriel, chief economist at Northern Trust. "In my view, none of these enhance our ability to grow faster in the future."
If a private sector investment boom were taking place in the U.S., Kasriel said the trade deficit would be tolerable, "but if we're just throwing a party" for consumers, other countries around the world might think twice about investing here.
Foreigners already have started to cut back their purchases of U.S. assets, according to the most recent data from the Treasury Department.
While it's fairly normal for budget deficits to widen during periods of weak economic growth, some economists have become concerned recently about soaring government debt.
"The budget deficit just seems like it's sitting out there waiting to be a damper on growth
by pushing up real rates," said Bill Cheney, chief economist at John Hancock Financial Advisors. The deficit is expected to soar to at least $480 billion next year, a new record high.
Still, Cheney doesn't expect the deficit to severely impact the economy in 2004. "I think that does create problems two or three years out, but I don't think it's a factor next year," he said.
Although questions remain about the quality of the economic recovery, there are certainly some positive developments taking place in the U.S. Productivity is soaring, the unemployment rate appears to be stabilizing and corporate profits are improving.
"There is no need for unwarranted pessimism," said Banerji. "The trade and budget deficit are serious longer-term issues, but in the next few quarters they're not enough to break the back of the recovery."
At least, not yet.