Growing, Growing ...Gone?

Sunday, Feb. 06, 2005 By PETER GUMBEL

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2004 was a year for the record books — the world economy grew at its fastest rate in almost three decades. And most observers predict that growth in 2005 will continue to be relatively robust in Asia, the U.S. and even laggardly Europe. The developed world, to paraphrase British Prime Minister Harold Macmillan's 1957 proclamation to his countrymen, has rarely had it so good. Why, then, are so many economists so nervous? Because even good times harbor real threats. Oil prices remain perilously high, well over $40 a bbl. since July. The dollar, despite some recent signs of life, has dropped by more than 40% against the euro since it began falling three years ago, and interest rates are creeping up: last week, the U.S. Federal Reserve raised rates for the sixth time in seven months. And lurking in the background is a two-headed beast that shows little sign of being tamed: America's soaring budget deficit, which is expected to exceed $400 billion this year (not including the forecast $100 billion-plus costs of military operations in Iraq and Afghanistan), and its record $660 billion current-account deficit, which means that U.S. imports of goods, services and money exceed exports in an amount equal to about 6% of the total U.S. economy. To cover the bill, foreign creditors must invest in that much American debt and assets. If they were to stop doing so, an unprecedented crisis could ensue.

Economists, of course, are famously dismal, so maybe it's no surprise that when Time's annual Board of Economists roundtable met during the World Economic Forum in Davos late last month, the discussion focused less on what is going right in the global economy than on what's wrong — and how serious the longer-term impact could be for everyone. Will the U.S. be able to continue sucking in the savings of people around the world to finance its profligacy? What is the likelihood that President George W. Bush — or the financial markets — will take corrective action? And could the twin deficits ultimately destabilize not just the U.S. but the entire global economy?

These questions were also on the table at last week's meeting of G-7 finance ministers in London, and for some, they have a historical echo. The two Americans on the panel, Jeffrey Sachs, the director of Columbia University's Earth Institute, and Laura D'Andrea Tyson, a former national economic adviser to President Bill Clinton who is now dean of the London Business School, see some eerie similarities with economic conditions of almost 20 years ago. As Ronald Reagan began his second term in 1985, the dollar was sliding and the U.S. was running up big deficits as a result of tax cuts and increased military and other spending. Back then, the American economy entered a turbulent decade of budget consolidation that included a short but potent recession, and bitter battles over spending cuts. Tyson and Sachs today believe President Bush may be in for an equally turbulent ride in his second term. With the Bush Administration doggedly pursuing a massive plan to overhaul the nation's Social Security system, and likely to face stiff resistance, tackling the deficits does not seem high on the agenda. Tyson said that "if there's anyone who believes" the Bush Administration will make a serious effort on the deficits, "I didn't find them." And unless priorities change, she expects interest rates in the U.S. to continue rising steadily until they hit around 5% — double their present level — and both she and Sachs predict painful budget cuts and a U.S. recession in the medium-term. "There'll be a wearing and exhausting process ahead. We're only in the first stage and it'll get ugly before it gets better," Sachs said.