Don’t believe the hype about the US ‘recovery’

published 9 February 2012

The bulls have a new story for investors to get excited about.

Don't worry about Greece and don't worry about China, because the US is on the mend.

Sure, things still look ugly out there - unemployment is high and house prices are still falling - but Federal Reserve chief Ben Bernanke can sort all that out with a bit of money-printing. After all, with all this deleveraging going on, we won't need to worry about inflation for a long, long time.

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Sounds good. And as we're seeing right now, the promise of more quantitative easing is certainly enough to give markets another sugar rush.

But don't get carried away. A new report from broker Tullett Prebon serves as a timely reminder that underneath all the sticking plaster of cheap money, the US hasn't even begun to address its problems.

America is more indebted than during the Great Depression

Feeling optimistic about the outlook for America? Well you shouldn't.

Dr Tim Morgan, global head of research at broker Tullett Prebon, has turned his eyes to the US. Morgan recently wrote a trilogy of reports on the state of the UK economy. My colleague Merryn Somerset Webb covered them on her blog. But if you missed that, don't worry. All you need to know is that the title of the series was "Project Armageddon".

Morgan's review of the state of the US isn't any cheerier. In short, America has too much debt. It's growing too slowly to get out of the debt hole. Now it needs serious structural reform (ie it needs to come up with a better idea than just printing more money in the hope that another consumer boom will kick off). And that's not going to happen for as long as politicians are too focused on winning elections to be honest with voters.

Take the debt first. In the ten years to 2011, America's total debt (private sector as well as public sector) has grown from 275% of GDP, to 358% of GDP. That's not as bad as the UK, but for the US, this is "unprecedented", "exceeding even the levels reached in the Great Depression".

And it's the rate of growth in the ratio that's the real problem. From 1945 to 1980, debt/GDP ranged between 130% and 170%, says Morgan. But the "credit supercycle" from 1980 saw the ratio roar upwards as the US economy was driven by "excessive debt-fuelled consumption". Now we're at the end of the supercycle, "no one seems to have worked out how to manage an economy that is not debt-propelled".

Lies, damn lies, and US inflation statistics

The other problem is that most Americans don't realise just how desperate their situation is, because the figures are fiddled. "Under a process which began in the early 1980s, reporting methodologies have been massaged to the point where the true scale of the economic malaise is masked from most Americans."

All the bad things debt, the deficit (the annual overspend), inflation and unemployment are understated. Meanwhile, "growth and absolute GDP, are flattered, and not to a minor but to a fundamental degree".

The official inflation figure is particularly misleading. There's 'hedonic adjustment', whereby if a product gets better, then it's deemed to be cheaper. So a $500 high-definition TV, say, is seen as being cheaper' than a $500 ordinary TV.

Then there's substitution, where if steak gets particularly expensive, consumers are assumed to buy chicken instead. As Morgan notes, as well as masking the true inflation figures, this "turns the index from a calibration of the cost of living to a measurement of the price of survival".

You've probably heard about these things before certainly if you've been reading MoneyWeek for any length of time. But the extent to which they distort the figures is staggering. Morgan reckons "true inflation might be at least 9%, rather than the 3.4% reported in December".

What does that mean? In short, it means that your average American could be a lot poorer than anyone imagines. If you take the official figures, the US dollar has lost 21% of its purchasing power in the last decade; if you assume the higher rate of inflation, it's more like 55%.

There is hope

The US has lots of other problems. Unemployment data are also fudged. And just as in Britain, in the past decade, too much money has been misallocated to property. And as in Britain, the financial sector has become too dominant.

You can argue that we knew all this already. But given the recent spurt of optimism over the US economy, it's a useful reminder that underneath all the money-printing and fudged statistics, America is in a bad way. And the solutions because they're politically difficult won't be reached for until things get far worse.

That's not to say that you should shun the States, or that there's no hope. For one thing, there are signs of a pick-up in the US manufacturing sector. With wages in China rising, and unions in the US more willing to compromise, the cost advantages of outsourcing is rapidly falling. The same can be said for the UK.

My colleague James McKeigue looks at how to profit from 'reshoring' in the next issue of MoneyWeek magazine, out tomorrow. If you're not already a subscriber, you can get your first three issues free here https://www.moneyweek.com/shop/moneyweek-free-trial.aspx.

The other point, as Merryn notes, also in the latest issue, is that in the short-term at least, what drives share prices is money flows. If everyone decides they like the look of the US better than anywhere else, then the country's stock market will do well.

But don't be fooled into thinking that the latest rally signals that the crisis is over and that a lasting recovery has begun. That's another good reason to hold onto gold as insurance just in case America doesn't manage to sort out its problems.

This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.