On the Brink of Trouble?

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The year 2004 was one 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. 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? When TIME's annual Board of Economists round table met during the World Economic Forum in Davos, Switzerland, 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 America's twin deficits ultimately destabilize not just the U.S. but the entire global economy? The U.S.'s soaring budget deficit 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 $617.7 billion trade deficit 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.

Economists, of course, are famously dismal in outlook, but these questions were also on the table at this month's meeting of G-7 finance ministers in London, and for some, they have a historical echo. The two Americans on TIME's 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 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 believe President Bush may be in for an equally turbulent ride during his second term. The Bush Administration is promising to reduce spending over the next five years. But as it pursues a massive plan to overhaul the nation's Social Security system, which is 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." Unless priorities change, she expects short-term interest rates in the U.S. to continue rising steadily until they hit about 5%--double their present level--and 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.