The grounding of the US economy is inevitable

Growth in U.S. gross domestic product in the January-March period (the first estimate of which will be released in late April) is expected to be at an annual rate of at least 2 percent for the seventh straight quarter, defying what was once widely expected that a rise in interest rates from the Federal Reserve will cause a recession. Economists first adjusted these forecasts to a “soft landing”, and now they are talking about a “no landing”, Ruchir Sharma, chairman of Rockefeller International, wrote for the Financial Times.

Conventional forecasting models have been more wrong than usual in this post-pandemic recovery. But why? Perhaps the most overlooked explanation for American resilience is that, to a much greater extent than other developed countries, the US continued to stimulate its economy well after the end of the 2020 recession.

Some of this fiscal and monetary stimulus is still flowing through the system, keeping growth artificially high and inflating consumer and asset prices.

Since the pandemic hit, Presidents Donald Trump and Joe Biden have made about $10 trillion in new spending, $8 trillion of which since the brief recession caused by Covid-19 restrictions ended in early 2020. US government spending is about $2 trillion a year higher than the pre-pandemic norm and on track to set records as a share of GDP.

Meanwhile, the rest of the developed world was going in a different direction. In the years since the start of the pandemic, rising deficits have amounted to a cumulative 40 percent of GDP in the US, twice the European average and a third more than in the UK.

By some estimates, fiscal stimulus accounts for more than a third of US growth in 2023; without them, the US would not look like such a miracle compared to other developed economies.

Even more underappreciated than untethered fiscal stimulus is the way monetary growth boosted the economy and financial markets. The Fed created so much money during the pandemic that, by some measures, the surplus has not yet been fully absorbed by the economy.

The broad measure of money supply, known as M2, which includes cash held in money market accounts and bank deposits as well as other forms of savings, is still well above its pre-pandemic trend. In Europe and the UK, where monetary stimulus has been less aggressive, M2 has already fallen back below its long-term trend.

This continued liquidity stimulus counteracts the Fed’s rate hikes and helps explain the current behavior of asset prices. Corporate profits have risen thanks to strong GDP growth, but stock prices — not to mention bitcoin, gold and many other assets — are rising even faster. This odd combination — higher stock valuations despite higher interest rates — hasn’t happened in any Fed tightening period since the late 1950s.

A similar levitation is visible in the housing market in the US – despite higher interest rates on mortgage loans, prices are rising faster than in other developed countries. As of 2020, total US household net worth has increased by nearly $40 trillion to $157 trillion, driven by housing and stock prices. For the more affluent, this “wealth effect” is a happy twist. More Americans plan to vacation abroad this summer than at any time since records began in the 1960s. For the poorer who vacation in the US, do not have their own home and are younger, these conditions are less favorable.

There are, of course, other plausible explanations for US resilience, including the surge in immigration and the boom in artificial intelligence (AI). Also, many U.S. borrowers pay fixed rates and won’t be affected by rate hikes until they have to refinance their loans. New government incentives are channeling billions in investment into subsidized industries from green technology to computer chips.

But one thing is clear: With both consumer and asset prices higher in the US than in other developed countries, the US economy is overheating and the Fed has less room than expected to cut rates. As long as interest rates stay higher for longer, the U.S. will face even bigger problems if it runs a deficit near 6 percent of GDP — twice the national average before the pandemic and six times the average since Western Europe. The US cannot sustain such aggressive stimulus indefinitely, with government spending already slowing.

However, economics is far from an exact science and it is difficult to know at what point the effects of incentives will wear off. But once it does, the landing could come faster than any conventional model now suggests, Sharma concludes.