The Golden Age Is Ending
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 playbut 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.