June 17, 2003
U.S. EconomyForget about expensive therapy sessions or your concerns about the advice of stock market analysts, now you can make sense of it all when you use the word "deflation." Whether you are late for a meeting, or are losing more value on your Las Vegas portfolio, or your business just went bust, you can blame it all on "deflation." Forget about "irrational exuberance," about the ".com’s," and the "New Economy," it is now "deflation." You don’t even have to worry about a weaker US dollar when you think "deflation." Of course, you will not find this version of the word in your traditional economics dictionary, it is used only by a select few in economic policy circles. So join this exclusive club now. Don’t waste your time analyzing the economy, just use the word "deflation" at your next cocktail party conversation, and you will become the talking point of the evening.
Recently, the Fed’s behavior has been symptomatic of a two-armed economist. On the one hand, there are excruciatingly discreet statements referring to the possibility of deflation – remember the Fed is referring to the personal consumption deflator as opposed to the consumer price index; on the other hand, the Fed Chairman recently referred to indications of a marked turnaround in the economy, whose timing was difficult to pinpoint. With respect to the consumer price index, consumer inflation expectations in May were down to 2.0 percent from 2.4 percent in April. Based on our moving average rate, annual inflation was 2.1 percent in May, and based on the assumption of an average monthly inflation rate of 0.2 percent through the end of this year, the average rate for this year would be 2.4 percent, a far cry from deflation. If we assume greater pass through of imported inflation as a result of the dollar’s maxi-depreciation, then inflation could be even higher.
As they have indicated, we think the Fed will go ahead and lower the Funds rate at its June 24-25 FOMC meeting, possibly to 1.0 percent. We still do not understand how such a move could bolster economic activity, when the drop from 6.50 percent to 1.50 percent was not so successful. We continue to insist, contrary to most analysts, that another rate cut would not provide a noticeable boost to economic growth but rather it would send the dollar’s value tumbling in the currency markets. Another rate cut by the Fed is likely to send the value of the Euro to the US$1.25 - 1.30/ € range. On the other hand, lowering the Fed Funds rate may be more desirable than attempting to force down long-term interest rates, a move that Fed officials indicated they are considering as an alternative strategy, and which goes counter to mainstream financial analysis.
The recently released Beige book by the Fed indicates that economic conditions remain sluggish. This is in line with our notion of a "non-recovery expansion." The quick resolution to the war in Iraq did not bolster consumer spending nor business investment. Industrial production has actually weakened in the last couple of months, although we think many of the problems in this sector have to do with the dollar and our structural trade imbalances.
The consumer sentiment index, as measured by the University of Michigan, dipped again in June to 87.2 from 92.1 in May. Fortunately, low interest rates continue to fuel mortgage refinancings and cash-outs from home equity, thus keeping consumer spending alive, but now losing steam. Thanks to record low interest rates consumer debt service has remained relatively low; however, the size of the debt has been increasing. Household debt as percent of disposable personal income has increased from 66.2 percent in 1980, to 82.5 percent in 1990, to 97.4 percent in 2000, and to 106.4 percent in 2002. When interest rates begin to move up again there could be some uncomfortable belt tightening by consumers.
Congress recently approved a downsized version of the President’s proposed economic growth and stimulus package with $350 billion in reduced taxes and other benefits over the 2004-2013 period. However, this figure represents the amount over a ten year period, and the future values are not comparable to current dollars. Based on an analysis prepared by the Congressional Budget Office, we conclude that about 15 percent of the stimulus could be in the form of income tax benefits and about 27 percent from the dividends tax cut. Nevertheless, the Federal government is currently running a huge deficit The cumulative deficit so far this year – October through May, is at $291 billion and rising. Of course a good part of the increase is due to the expense of the war in Iraq. We think that fiscal stimulus could be more effective in supporting economic growth at this stage of the business cycle than monetary policy. In this regard the deficits are not necessarily a bad thing for the economy.
In keeping with our regular monitoring of the bulging U.S. external deficit, the latest trade statistics for April show the annual trade deficit at $520 billion. We expect the current account deficit to reach about 5.0 percent of GDP this year.
Latin American Economies
Nestor Kirchner was recently sworn in as president of Argentina. Kirchner’s opponent in the second round elections, former president Carlos Menem, decided to withdraw in view of his poor showing in the opinion polls.
The Argentinean economy grew by a strong 5.3 percent in the first quarter of 2003, compared to the same period of the previous year. However, a deceleration is expected in the second quarter, due to political uncertainties caused by the presidential elections.
The Bolivianeconomy is still struggling. Some growth has been observed in the gas and oil sector, agriculture and utilities. However, non-oil mining, construction, commerce, transportation and finance have yet to recover.
Brazil’s economic growth in the first quarter is estimated at 2.0 percent. First quarter statistics compare favorably to the weak figures posted in same period of the previous year, when electricity rationing was in place. The external sector has been performing very well up to May, with exports growing by 30.6 percentOn June 6, Chile and the United States signed a free trade agreement in Miami. Chile expects that exports to the U.S. will increase by US$1.4 billion in the next four years. Among the biggest beneficiaries from this agreement are Chilean textiles.
The Colombian Minister of Finance, Roberto Junguito, resigned and was replaced by the vice-minister, Alberto Carrasquilla. GDP growth for the first quarter reached 3.8 percent, led by construction, manufacturing, transportation and communication.
Costa Rica’s economy is showing signs of improvement. Economic activity was expanding at an estimated 5.8 percent in the first four months of the year, according to the monthly estimator of economic activity. Exports were growing at 22.5 percent during the January-April period.
The BanInter scandal in Dominican Republic has further shaken the already battered peso, which is now flirting with the RD$30/US$ mark. The peso has depreciated by about 28 percent, since the end of 2002. The authorities have been trying to obtain financial support from the U.S. government and the multilateral agencies. However, those institutions want an agreement with the IMF as a prerequisite.
Ecuador started negotiations with the Paris Club for the rescheduling of its official debt.
Gross Domestic Product expanded by 2.3 percent in Mexico, during the first quarter, led by growth of 5.9 percent in construction.
Port activity in Panama expanded strongly by 14.3 percent in the first quarter. However, banana exports have been disappointing. Banana exports prospects are expected to worsen in the second half of this year, due to an oversupply in the world markets.
Nicanor Duarte has been elected president of Paraguay. His economic team, which counts with the blessings of the business community, will be comprised mostly of officials from the former administration of Luis Gonzalez Macchi.
Peruvian exports were growing by 22.5 percent during the first four months of this year.