Beware of the bull

Observations on US economy

It's incredible, but true. The mighty US stock market is defying gravity. The unbelievable element is that the Dow Jones Industrial Average - the Americans' main share-price index - is roaring, against a slew of evidence that beyond Wall Street, America's broader economy is in very serious trouble. The Dow has in past days hit a new high, touching 11,720, a level not seen since January 2000, when shares surged off the back of post-millennium hubris and the dotcom boom.

Stockbrokers - in the United States and elsewhere - will tell you I am wrong. But, share-price hype aside, America's prospects look ghastly. With apologies to Al Gore, that is the real (economic) "inconvenient truth".

This past week, we learned that the US economy grew by only 2.6 per cent in the second quarter of this year - down from 5.6 per cent during the previous three months. That is a dramatic downturn by any standards. And given that we are talking about the world's largest economy - the biggest consumer and importer on the planet - any uneasiness in America affects us all.

The latest data shows that US consumer spending, the economy's mainspring, has also slumped - in large part because there are finally signs of cracks in the country's ultra-resilient housing market.

In August, house prices were 2 per cent lower than the previous year. That represents the first fall in US property values since 1996 - and the largest drop since Saddam Hussein invaded Kuwait back in 1990, the prelude to the first Gulf war.

As in Britain, in recent years Americans have borrowed heavily against their homes. This has sparked a consumer spending spree that has generated more than half of the country's growth, and millions of jobs. That growth, in turn, has sucked in goods from around the world - fuelling export booms in Asia and Europe, including the UK.

But the music has stopped. There is a property glut, with the stock of unsold homes some 60 per cent higher than last year. And, without the rocket fuel of ever-rising house prices, Middle America is thinking less about shopping these days than about higher debts and shaky job prospects. All of which raises the question of why the stock market is, none the less, booming.

The reasons are complex, but one important factor is that, as it confronts the rising cost of oil, the United States also has an inflation problem. That is why the Federal Reserve - America's central bank - has raised interest rates 17 times in a row now, to 5.25 per cent. Even so, inflation remains at a ten-year high.

But, instead of rates rising further, the futures market is predicting they will soon be cut. The harsh reality is that property prices in the US are now so precarious - and an almighty crash would be so catastrophic - that the Fed is about to take the emergency measure of slashing rates in the face of high inflation.

The US stock market, myopic in the extreme, has seized on these impending rate cuts as "good news"! That is the main reason shares have soared. No matter that the country's prospects are so grim that lower interest rates are needed to head off a recession. Who cares about the recession if rates are coming down . . . ?

When America sneezes, the rest of the world catches a cold. It's a cliché, certainly, but it's true. Irrespective of China, India and other "emerging giants", the US remains the world's economic powerhouse.

Whether we like it or not, our economic futures are bound up with America's. But stay away from US stocks. And, while you're at it, stay away from the dollar. This is an economy heading south.

Liam Halligan is economics editor of the Sunday Telegraph

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