March 18, 2004
U.S. EconomyMany have asked the question, what distinguishes the short-run from the long-run, but few have provided a convincing answer. John Maynard Keynes, the famous 20th Century economist, pointed to the inevitable reality that "in the long-run we are all dead." Economists, who developed the field of Finance, came up with a quick rule: the short-run is a period of time less than 365 days. Accountants, who developed a methodology to measure profits based on the definition developed by economists centuries ago, usually rely on whatever GAAP prescribes on this issue. But the most revealing characterization was provided by a well-known Central Banker who said that the long-run is a "considerable period", and who further elucidated this subject by clarifying that the long-run will occur "at some point." In the meantime, the short-run may best be described as the period during which the Fed Funds rate will remain at 1.00 percent.
Economic activity continues to expand at a healthy pace. We anticipate first quarter GDP growth of 3.75 percent, just under the 4.1 percent posted for the fourth quarter of last year. Business investment has perked up since the middle of last year, with all of the growth in capital spending focused on equipment and software, since spending on structures has been declining. The decline in structures could be a signal of offshore production displacing domestic capacity in the low-end of the technology spectrum, while U.S. firms beef up their capital intensive processes. Thus a good part of the so-called excess capacity may just be hollow plant facilities that have been displaced by offshore production. If so, this also explains why job growth has been limited: first, businesses want to avoid any increase in overhead; and two, they are outsourcing both assembly line as well as professional workers offshore. At the same time U.S.-based producers are substituting more capital, in the form of computers and other equipment, for labor. Because of these factors, we think the unemployment rate will remain relatively high even as the economy continues to expand. Nevertheless, industrial production is doing very well, with the February index 2.7 percent above the same month last year.
One area for concern has been the recent weakening in the housing sector. Starts fell during the January - February period. Consumer sentiment is still vulnerable. Key factors in determining consumer sentiment are: the unemployment rate (-), return on the stock market(+), percent change in home prices(-); interest rates(neutral); and the level of the terror alert index(-). The sign in parenthesis indicates our view of how this factor is currently contributing to consumer sentiment. The recent tragic terrorist attack in Spain, which may have been timed to affect the outcome of the general elections (the Popular party was expected to win according the polls prior to the attack), has raised anxiety levels of U.S. consumers.
Inflation appears to be tame for the next several months, but rising again towards the end of the year. Our moving average CPI inflation index stood at 2.2 percent in January. We expect the rate to move up to 2.6 percent by the end of this year. Consumer inflation expectations based on the University of Michigan consumer survey was 2.7 percent in February. Higher than normal productivity growth and flat unit labor costs have contributed to the cooling off of inflation, but as the economy continues to expand, demand driven price pressures will materialize. As gasoline prices continue to climb, inflation will also respond accordingly.
The twin deficits – the trade and fiscal deficits continue to bulge. The latest CBO projections for the fiscal deficits are somber. We are also forecasting an unprecedented trade deficit, which could reach as high as 6 percent of GDP this year. The hemorrhaging of the fiscal and international trade accounts will impact long-term interest rates, through the risk premium, and further weakening of the dollar. We think it is inconsistent to expect long-term interest rates to fall while the fiscal and trade deficits continue to surge beyond manageable levels, and are unlikely to show any improvement in the medium-term. Election year politics will also contribute to greater volatility in the financial markets this year.
Latin American Economies
Argentine
agricultural exports are expected to rise 7.0 percent this year. Credit to the private sector has been going up in recent months. However, mortgages remain depressed.President Mesa has been consolidating his position in
Bolivia with an approval rate of 78 percent, according to the latest polls.First quarter GDP in
Brazil for this year is expected to hover around 1.0 percent, per Planning Ministry estimates.The
Chilean Superintendency of Banks estimates a return on capital for the banking system this year of between 15 - 17 percent, with growth of 5 - 6 percent in total loans, 10 - 12 percent in consumer loans, 8 - 10 percent in mortgages and 4 - 5 percent commercial.Preliminary estimates indicate GDP growth of 3.6 percent in
Colombia for 2003, which would be the highest in the past six years. Growth was widespread, led by construction and mining.Costa Rica
’s inflation has picked up since the beginning of the year, mainly due to higher oil prices.Dominican Republic
and the U.S. signed a free trade agreement.In
El Salvador, ARENA’s presidential candidate Antonio Saca has been widening his distance from FMLN’s Handal in the last few days before the elections of March 21. He now could win in the first round. However, about 20 percent of voters remain undecided. Opinion polls show that in a second round, ARENA would easily defeat any candidate.Perspectives are improving for the
Panamanian economy. Construction, tourism, port activity and telecommunications are showing significant dynamism. On the other hand, Colon Free Zone exports and imports keep declining.The referendum saga continues in
Venezuela. The Supreme Court ordered the reinstatement of over 800,000 disputed signatures in favor of the referendum, that had been rejected by the Electoral Council. If that order holds, the opposition would have enough signatures for the referendum. However, the government will appeal on Constitutional grounds.