The US economy looks distinctly Old World

Commentators at the Paris Europlace Financial Forum in Hong Kong point to a prolonged period of US weakness, a booming Asia and a resurgent European Union.
When the revitalised Eastern European countries of the former Soviet Union queued up to support the US invasion of Iraq in 2003 (in the face of French opposition), there was much talk of the æOld EuropeÆ versus the æNew EuropeÆ.

That bifurcation between fast-growing dynamic economies and slow, lumbering economies is now becoming increasingly commonplace when referring to the US and the rest of the world, according to the speeches made at the Paris Europlace International Financial Forum held in Hong Kong on Monday. And ironically, it is the US that is being described in the same unflattering terms as æOld EuropeÆ was then.

ôIn the wake of the subprime debacle, the US is going to bump along at sub-trend growth for some time," says Paul Mortimer Lee, global head of market economics at BNP Paribas and a speaker at the conference. "That will help the economy recover from the imbalances that have plagued it over the past few years. And hopefully it means that the US will not fall into a recession.ö Mortimer Lee reckons the US economy will grow by just 1.28% next year, rising to 1.9% in 2009.

In contrast, Mortimer Lee sees continuing strong growth for the Asian economies. ôIt makes sense to put your money in Asian stocks, that's clearly where the momentum is,ö he says, referring to AsiaÆs strong current account positions, favourable budget situations and high savings rates. In contrast, he is particularly concerned with the weak housing market in the US. The huge housing stock overhang in the US, inexorably sinking in value, will ultimately have a ævery profoundÆ effect on the economy, he says.

ôSo far, we have not seen the full effect of the credit crunch on the real economy. We are currently seeing a period of relative financial calm, but itÆs deceiving. Sooner rather than later we will see an impact on US unemployment rates and a rapid decrease in US incomes." Consumption canÆt help but dry up as the wealth represented by consumerÆs housing begins to decrease, he adds.

Mortimer Lee is also bullish on the European Union (EU), which he sees as outgrowing the US in the short- to medium-term.

ôThe æbusiness modelÆ of recent US economic activity was consumption based on debt. That debt burden was so great that its accumulation now needs to slow û thereby slowing the economy,ö he says. ôIn contrast, the business model of the EU has been investment and exports. This has been further stimulated by the proximity to the growing Eastern European markets, the Middle East and the strengthening links between the EU and Asia.ö

In fact, Mortimer Lee says the US economic model over the past few years has produced a series of ever-bigger bubbles, from the Tequila crisis in 1995, to the tech bubble in 2001, and now the current credit crunch.

This year, the EU has for the first time overtaken the US as an export market for China. The EU is now ChinaÆs single biggest export partner, at just over 20% of the total. Mortimer Lee also estimates that the EU economy is more exposed to trade than the US.

ôFinance follows trade,ö notes Mortimer Lee, alluding to the possibility that the EU might ultimately become a more important financial centre than the US.

On the currency front, there will be a major difference in the fate of the euro versus the dollar, with the dollar continuing to sink, possibly to as much as 1.60, compared to 1.4 currently (and 1.27 one year ago). The euro, in contrast, will continue to strengthen against most currencies û since unlike most Asian central banks, the European Central Bank does not have a policy of actively intervening in the currency market to protect its exporters.

That currency divergence will be accentuated by continuing swinging interest rate cuts in the US, which could push the Fed funds rate down to 3.5% by next year from 5.75% today, compared to 4% in the EU next year.

ôThe fact that the Fed cut rates by 50bp in September is a sign they are treating the credit crunch as potentially being very serious.ö

The United Kingdom, however, will not fare as well as the rest of Europe, because its economy shares many of the same characteristics as the US economy: high debt levels, poor government finances (at almost 3%, the UK has the worst budget deficit in Western Europe) and over-reliance on the financial and housing markets to prop up consumption and drive growth.

ôIn fact, the UK can be seen as being in even worse shape than the US, because the US economy is far more diversified thanks to its automobile, manufacturing and IT sectors,ö notes one economist, who predicts that the British pound will also weaken.

The Bank of England, the Treasury and the Financial Services Authority have also lost credibility over the Northern Rock affair, since it wasnÆt clear who was to lead the rescue operations. ôThe government should have nationalised Northern Rock, rather than appear to bail out shareholders and depositors via a blanket guarantee,ö says Mortimer Lee.

Mortimer Lee says that since the government pledged to stand by Northern Rock, hedge funds have been combing through the books of other aggressive UK mortgage lenders and shorting them, hoping to repeat the millions of pounds they made shorting stock in Northern Rock.

ôPotentially, that sort of behaviour could lead to a knock-on effect of collapsing banks and threaten the financial system.ö
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