Economic expansion no longer provides the old returns and the impending midterm elections will only worsen the political gridlock. Meanwhile, volatility is increasing in the markets.
The global financial crisis began when consumption collapsed in the U.S. Today, American consumer is leading global economy again, thanks to the Fed's lifeline support of $4.5 trillion.
Soaring markets, shriveled trade and excessive debt
In October 2007, the Dow Jones Industrial Average closed at a record high of 14165. After the global financial crisis, the market peak was not matched until March 2013. Since June, the DJIA, except for occasional plunges, has been above or close to 17000 — almost 20 percent higher than in October 2007.
What about the gains in international trade? Well, the Baltic Dry Index (BDI) is shorthand for commodity-driven international trade, which peaked at 11793 in May 2008. Now, if markets truly reflected real economies and globalization is picking up, one would expect the BDI to hover above 14100 today. In reality, the indicator is closer to 1400 – almost 90 percent lower than the peak. This disconnect illustrates the huge gap between the high market expectations and the stagnation of the real economy.
In fall 2008, the massive global market collapse was triggered by dramatic declines in the U.S. financial sector and subprime real estate. But ultimately, the great recession was driven by the plunge of consumption, which accounted for more than 70 percent of U.S. GDP.
After the crisis faded, there was much talk in the G20 summits about global growth that should not rely excessively on the aging and over-leveraged American consumer. Yet, today the U.S. economy is again playing a vital role in driving global growth — and the leverage is far worse.
In fall 2008, the U.S. national debt soared to $10.2 trillion, or 68 percent of the U.S. GDP. Today, it is close to $16.8 trillion, or almost 100 percent of the U.S. economy.
Despite all the rhetoric about "austerity" and "rebalancing" America's debt burden has grown by almost two-thirds since the crisis year of 2008.
Growth on low rates
In 2014, U.S. real GDP growth is expected to increase to 2.1 percent, and markets anticipate 3 percent by 2015-2016. Yet, inflation is expected to stay below 2 percent into the mid-decade.
In August, inflation unexpectedly cooled, which flustered the U.S. bond market. Unsurprisingly, Federal Reserve Chair Janet Yellen believes the labor market continues to suffer from substantial challenges, which require the Fed to retain its interest-rate pledge for a "considerable time."
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As the Fed has now officially ended its large-scale debt purchases, Yellen is determined not to raise the policy rates too early because that would hurt the fragile recovery. Markets expect the first hikes by mid-2015.
What these forecasts consistently downplay are the global feedback loops.
During the Great Recession, central bank coordination worldwide was vital to monetary and credit easing. So when Yellen and her second-in-command Stanley Fischer arrived at the Fed, both made it clear that rate hikes in America would be cognizant of potential implications elsewhere.
Now the tone is shifting. In a recent keynote at the IMF, Fischer argued that while central bank coordination may have been critical during the crisis, but the time of policy rate normalization is a different story.
U.S. monetary policy is determined by the Fed's dual mandate, U.S. employment and U.S. prices, not their global counterparts. This policy may incorporate the impact on foreign economies, but only to the extent that those impacts feed back into U.S. outlook for domestic growth and inflation.
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During the global crisis, the Fed's then-chief, Ben Bernanke, portrayed it as the world's lender of last resort. Today, the potentially adverse global impacts of the Fed's expected hikes are presented as almost inevitable "collateral damage" that's not America's concern.
And that, precisely, is a potentially disastrous mistake. In the emerging world, that's seen as a double standard and extraordinary arrogance — America as not a "responsible stakeholder."
Expanding economy, shrinking labor force
In September, the unemployment rate fell below 6 percent for the first time since July 2008. As some 248,000 new jobs were created, the jobless rate declined to 5.9 percent. That's not so far from the 5.2-5.5 percent range that the Fed considers a benchmark for rate hikes.
Not long ago, the decline of the unemployment rate went hand in hand with rising labor participation and growing incomes. That's not the case anymore.
The broadest alternative indicator of unemployment takes into account the unemployed but also the marginally attached workers plus those employed part time for economic reasons. Despite the pickup in hiring, that measure remains 11.8 percent. Moreover, every third unemployed is suffering from long-term unemployment.
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Moreover, despite strengthening growth and decreasing unemployment, the share of working-age Americans who have a job or are looking for one has collapsed. Before the great recession, the labor-force participation rate was at 66 percent. Last month, it fell to a three-decade low of 62.7 percent.
As some 18.5 million Americans remain unemployed or under-employed, only a part of this plunge is due to aging baby boomers. Participation is record low even among Americans in their prime working age of 25 to 54.
What's worse is that, despite the rebound, workers' wages are frozen. Among private-sector workers, average hourly earnings decreased a penny last month, to $24.53. Current recovery is the second expansion since the 2001 recession in which economic growth is not translating to rising incomes for most Americans.
After the midterm elections, Republicans are likely to maintain control of the House of Representatives and, after eight years, they could have the majority in both the House and the Senate again. This outcome would mean a huge political gridlock just two years before the next presidential elections.
Despite recovery and expansion, the labor force remains downscaled and productivity growth is weak, which ensures that the Fed can defer hikes, even if the rate of unemployment is adequately low.
In comparison to Europe or Japan, the U.S. economy seems strong. But not everything that shines is gold.
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