The perils of a recovering U.S. economy: Don Pittis

On the face of it the numbers certainly look good.

With every revision, the U.S. Commerce Department has upped its estimate. On Friday, its third and final assessment showed gross domestic product increasing at ahealthy rate of 4.6 per cent this spring.

Five per cent growth in a mature advanced economy is a strong number. Since the Second World War, the average U.S. annual growth rate has been just over three per cent.

• U.S. GDP expanded by 4.6% in 2nd quarter
• Canadian economy expands at 3.1% pace in 2nd quarter

But more important, it is easy to forget that despite all its troubles, the economy of our southern neighbour remains the world's hugest. Five per cent growth in that single economy represents something near a trillion dollars added to the globe's economic activity.

And for the country's biggest trading partner, that kind of growth cannot help washing over the long undefended border.

Don't expect a smooth transition

Despite much worse figures in the first three months of the year, widely blamed on weather, these are not just good growth numbers.They are trending toward spectacular. And so long as this is not just another false dawn, the transformation to sustained growth is, unfortunately, not likely to be smooth.

But before getting gloomy I should mention some of the positive signs buried in Friday's statistics. Consumer spending was relatively weak, but another way of thinking of that is that consumers are keeping their powder dry, holding back on spending till they are confident the corner has been turned. For the economy, that is money in the bank.

The place where the growth really happened was in business spending.

"Real non-residential fixed investment increased 9.7 per cent in the second quarter," says the Bureau of Economic Analysis in its release, up from less than two per cent in the previous quarter. Investment in office buildings and factories grew nearly 13 per cent, up from three. Equipment purchases rose 11 per cent up from a decline of one per cent.

Is there pent-up growth?

While some of those increases could represent investments delayed from the frigid first quarter, business spending of that magnitude may signal the beginning of a virtuous circle, releasing a pent-up surge in real investment in the economy that has been lacking during the last seven years of economic doldrums.

Not that there hasn't been lots of money floating around. It's just that new business investment, the kind that creates jobs and represents the rumbling engine of growth, has been in short supply. Instead, all that money has been bidding up the price of existing assets.

And of course that is where we come to the rough patch, not just in the United States but in Canada and many other parts of the world.

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As I have moaned about many times in the past, all that money our governments and central banks keep pumping into the economy has been doing little but inflate the value of stocks. And Canadian houses.

Asset buying has created a virtuous circle of its own, as rising prices and low interest rates encourage the well-heeled to borrow and bid prices even higher. That has made them a lot richer, at least on paper, but it has done little to stimulate the productive part of the economy.

Spiral down in assets

The danger now is that as the U.S. central bank tightens the money supply by cutting bond buying and raising interest rates, this asset-based part of the economy will move from a virtuous circle to its opposite, the vicious spiral.

In the long run this is a good thing, and must happen. As we've seen, during periods of rising asset prices there is no need for businesses to invest. In such times, money tucked away in stocks (or Canadian houses) will turn into more money, even if the productive capacity of the country as a whole remains relatively unchanged.

And with luck, this is about to change. In the next phase the companies that do well will not be those cutting staff and increasing profitability. It will not be the companies that count on artificially low interest rates to borrow to buy back their own stock.

In the real growth stage of an economy the companies that do well are those that hire and expand, the ones that invest to turn good ideas into excellent products and services. That in turn means good jobs and, eventually, a surge in consumer spending. It is what we have been waiting for.

But the transition is a tricky one that must be well managed. A disruptive crash in markets will do no one any good. A 50 per cent fall in Canadian house prices as predicted by Hilliard MacBeth last week, could overwhelm the economic benefits of a low Canadian dollar and a U.S. growth spurt.

With luck, strong U.S. growth means there is only a short gap between the Great Recession and recovery. But hang on tight. It may be a rough crossing.