MACROECONOMIC ANALYSIS

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The US economy continues to surprise on the upside, posting relatively sustained growth since the flash recession in the first half of 2022. Over the last few quarters, economic activity has been expanding at a rate that would make the world's major developed countries green with envy. The job market is still growing, while productivity is posting gains after several quarters of contraction. The strength of the US economy is even more impressive when compared with that of the Eurozone, which has literally stagnated for five quarters in a row (see Fig. 2). Admittedly, such a gap has been seen on several occasions in the past (see Fig. 3), but are investors right to wonder whether it is a miracle or whether Uncle Sam has a justifiable and lasting advantage?

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A historical comparison of the current cycle suggests that it is business as usual. The exit from recession is perfectly in line with the average of the previous eight cycles (see Fig. 4). Real gross domestic product (GDP adjusted for inflation) has risen by 12% since the last crisis, as in most cases.

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Looking to the future, investors will note that the business outlook is not sparkling, but it is relatively good, in line with the current phase of the economic cycle. The business confidence index published by the Institute of Supply Managers points to annual growth around 2.5% in 2024 (see Fig. 5). Better still, the trend is improving as the index gains momentum.

The point on which everyone agrees, but the extent of which is underestimated, concerns the US budget deficit. The gap between government spending (on healthcare, pensions, defence, education, etc.) and the revenue it collects (taxes and other charges) has rarely been so unbalanced. Usually, it is Europe that is known for the structural and complacent nature of these budget deficits, linked to its highly accommodating fiscal policies. However, it has to be said that over the last 15 years and the subprime crisis, public finances in the United States have been in much greater deficit than on the Old Continent (see Fig. 6). The Covid-19 pandemic has exacerbated the differences. Last year, for example, the US posted a budget imbalance equivalent to 7.5% of GDP, compared with 2.9% in the Eurozone. While the Trump administration sought to reduce taxes on businesses and households, the Biden administration aims to increase spending and subsidies to support the same economic players. In both cases, the consequence is similar: the budget deficit is growing. The State is living beyond its means.

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Between 2006 and 2015, the budget deficit gap between the United States and Europe helped to explain the growth surplus in the former. Since 2016, economists have been forced to recognise that part of this budget deficit is not productive. Annual GDP growth in the US should have been 2% to 7% higher than in the Eurozone, but in reality it was 0% to 4% (see Fig. 7).

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Since most investors have carefully put their macroeconomic books in the attic, let's briefly remind ourselves that there are two kinds of budget deficit: good and bad.

▪ The first aims to improve the marginal productivity of private capital (bridges, motorways, hospitals, the education system, etc.) and therefore long-term production; it is a profitable investment.

▪ Conversely, the second involves spending tomorrow's income today; i.e. "borrowing" from future generations.

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While a bad deficit can be considered temporarily, in order to avoid a systemic crisis or to boost growth during a recession, it absolutely must remain exceptional. If it becomes recurrent, part of the deficit will be spent on less profitable projects. In practical terms, a 1% deficit will generate less than 1% growth. This is what has been happening since 2016. To make matters worse, a bad deficit reduces long-term growth, which is the exact opposite of a good deficit, because the interest burden on sovereign debt ends up curbing the State's ability to spend.

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Government spending can be seen directly but also indirectly, through businesses and households who will spend the amounts they have benefited from. In the case of the US, around 60% of the federal government's budget is spent on payments to households or on behalf of them, while 69% of GDP is made up of consumer spending. It is fairly easy to link the two ratios: budget deficits lead to consumption that would not have taken place without them, and therefore to an artificial inflation of GDP.

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If we look at the flip side of the same coin, we can see that in recent years, without the deficits conceded by the public administration, US growth would have been negative (see Chart of the Week). A substantial proportion of budget deficits have not been reflected in growth :

▪ Either because the benefits of the investments made will only be visible in a few years' time (good deficit)

▪ Or because they were spent abroad, importing production from other countries (bad deficit)

▪ Or because they have been saved, with the aim of being invested or consumed at a later date (good or bad deficit).

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Without going too far into macroeconomic analysis, it is interesting to note that Ricardian equivalence does not seem to apply. The theory states that when the government goes into debt to provide fiscal stimulus, businesses and households anticipate a future rise in taxes and reduce their investment and consumption, thereby counteracting the effect of the fiscal stimulus on activity. The empirical study of the American case, on the other hand, demonstrates the stability of savings and the effectiveness of budget deficits on economic growth... at least in the short term.

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Another piece of good news is that the recurrence of deficits does not seem to be causing any particular concern about the solvency of US sovereign debt. The special status enjoyed by the United States, as the world's leading economic and military power, with the dollar dominating international trade, is giving bond investors peace of mind... at least for the time being.

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Conclusion :

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Given the economic fundamentals, the growth surplus that the United States is managing to generate relative to the Eurozone is justifiable and sustainable. However, the strategy of relying on public spending in deficit combines two drawbacks: not only does it generate a disappointing growth surplus, but it often involves 'borrowing' prosperity from future generations.

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