The Golden Age Is Ending
By Mortimer B. Zuckerman
Posted 7/29/07
http://www.usnews.com/usnews/opinion/articles/070729/6edit.htm

We have been enjoying a golden age. In the latter part of the 1990s and the first part of the 21st century, every indicator of economic health that should be up has been up: employment, income growth, stock market profitability. And everything that should be down has been down: inflation, interest rates, and unemployment. Inflation in the United States was contained by a fortuitous combination of a glut in global productive capacity, foreign competition, technological innovation, and the soaring dollar, which made imports cheaper. Everything that China exported went down in price (and everything that China imported went up in price). So we had more productivity here, more jobs, more growth, and pay rises without inflation.

Today, many of these benign forces are still in play—but to a much lesser extent. The dollar is no longer soaring but slumping, as the world engine for growth moves from the United States to the East. To get a sense of how critical Asia has become, consider that our economy is expected to expand by $526 billion this year. The Chinese economy, which is a fraction the size of the U.S. economy, is expected to grow by $420 billion. That divergence will persist as China, as well as India, grows at a 10 percent annual rate.

This is the story virtually everywhere in the developing world-tightening markets for labor and product, with inflation pressures waxing. Central banks in Europe, China, and Japan are responding with rate hikes and hawkish rhetoric. Stronger growth around the world will portend even higher interest rates.

Prices rise. A collateral result of tighter money and higher interest rates is that the currency exchange rates of these booming countries have appreciated. The dollar has plunged roughly 4 percent just in the past few months and on a trade-rated basis compared with a basket of major currencies is now down some 30 percent from its 2002 peak. Import prices have risen, which now adds rather than abates inflationary pressures here. Wage costs in foreign countries have given another twist to the spiral, not dramatic yet but noticeable: In the past several months we have been paying about 2 percent more for consumer imports, excluding autos, the fastest such advance in more than a decade. This time last year, these prices were falling.

There is no prospect of these global inflationary pressures easing. Emerging nations are enjoying rising aspirations, higher living standards, and rising incomes. Demands for food, consumer goods, automobiles, and trucks are increasing, and so are the demands for improved education and labor training. The result is increases in costs that are rising more rapidly than technology can reduce them.

Our ballooning trade deficit is a function of these global forces. Fortunately, foreign investors have been happy to underwrite our red ink by pumping nearly $800 billion into our financial markets annually. Asian banks especially have been buying large quantities of dollars and dollar-denominated securities. The big question is how much these accumulated savings will be siphoned off by our trading partners for their own domestic growth. Clearly, rising global real yield will put a floor under U.S. interest rates, limiting our ability to manage our monetary policy.

The "golden age" has therefore resulted in an immense rise in foreign ownership of all American securities. Foreigners own more than half the federal debt, about a third of corporate bonds, and 13 percent of the U.S. stock market. This represents an accumulating claim on the future output of the United States and foretells an increasing flow of dividends and interest payments abroad.

It doesn't help that Americans save so little. Personal saving rates over the past 15 years have gone down from 7 ½ percent to zero. The aggregate national saving rate, which includes the public sector and private corporations, has dropped from 13 percent in the 1960s to 0.8 percent last year. The average American with an income of about $40,000 saves virtually nothing, while the average Chinese, earning somewhat above $2,000 a year, puts away about 20 percent of his income. Compound a low savings rate with a trade gap that has nearly doubled to 7 percent of gross domestic product over 20 years, and we can understand why the net international investment position of the United States has declined from what was a modest plus-5 percent of GDP in the mid-1980s to its current minus-20 percent.

In short, we are no longer as dominant in the world's economy as we were. Everybody's lives will be affected by that. That includes both national and individual rates of growth, as well as inflation and interest rates. The trend of gradual disinflation here and around the world that we have enjoyed for the past 25 years under the pressure of price competition from imports is drawing to an end. We are now looking at a period of rising inflation driven in good part by the economic successes around the world.