Is this the new mantra that is eventually going to change the US economy structurally? Latest data suggests that savings rate for Uncle Sam’s America grew faster than consumption expenditure. While consumption expenditure grew 1.6% in the second quarter, savings rate shot up to 6.4%. The US economy thrives on consumption expenditure, which accounts for over 70% of the GDP. A high savings rate implies that consumption expenditure will remain subdued and economic growth will suffer.
While a healthy savings rate is usually considered good for an economy as it provides capital for investment, the US economy has structurally modified itself to a certain extent such that it can attract capital from overseas very easily and it is more dependent on imports for its goods than producing them at home. With this structural model, the more the American consumer spends and the less he saves, the GDP grows. But, is this model sustainable? Well as long as the rest of the world is willing to lend to the US to fund its consumption expenditure, it is a feasible proposition.
Unfortunately, this is where the problem lies. The rest of the world would be willing to invest in US paper as long as the dollar is stable and the investments fetch returns. Stability of the dollar hedges currency risk and the possibility of erosion of long term value of the investment. The stability and the value of the dollar are linked to the health of the US economy, which include GDP growth, interest rate, inflation, fiscal deficit, current account deficit and other such parameters.
USGDP growth decelerated to 2.4% in the second quarter of this year from 3.7% in the first quarter, clearly indicating that the US is not yet on a sustainable growth path and, as the impact of the stimulus wears off, the US economy is beginning to slack. Interest rates, the monetary lever for stimulating economic growth are close to zero. Trillions have already been spent as fiscal stimulus, which add to the fiscal deficit. The state of economic recovery suggests that there is need for further fiscal stimulus as the monetary lever cannot help any further. This is going to impact the fiscal deficit and the fiscal reputation of the US. Such eventualities can cause an erosion of faith in the US dollar and slacken the world’s keenness to lend to the US economy.
The tax cuts implemented by the Bush administration as a part of the fiscal stimulus are set to expire in by the end of this year and a debate is ensuing on what should be done next. U.S. Treasury Secretary Timothy Geithner is of the view that tax cuts cannot pay for themselves via stimulation of economic growth. The US government reportedly wants to lapse tax cuts for households earning more than $250,000 a year, while continuing tax breaks for households earning less than $250,000 per year.
The fine balancing act that the government does at this point to lubricate the economy on the one hand and to keep the fiscal health of the US on the other hand are key to determine the strength of the US dollar going ahead.