When reality attacks

Problems are brewing in the financial sectors of Bushworld:

Coupled with worries about the high price of oil, the nation's ballooning domestic budget and foreign trade deficits, concerns over the cost of health care, the escalating costs of one war and the costs of likely future adventures, few are willing to make boldly optimistic forecasts for the US economy.

Despite a rise in the markets, the focus of concern last week was on the dollar's continuing decline and intensifying worries that mounting US budget and trade deficits could collapse the currency. While treasury officials dismissed the scenario as a scare story, economists said the dollar could be heading for a severe sell-off unless the White House and Congress made serious efforts to shrink the budget gap.

JP Morgan warned clients of a growing 'recognition in the markets of the need for more dollar depreciation'. Company analysts added that the administration's lack of effort to rein in the deficit, and the reliance on foreign investors to pour money into US securities to cover the imbalance, threatened US economic stability. Many predict the dollar will continue to fall, and by as much as 20 per cent.

'The economy has major negative headwinds, and we're going to see economic growth weaker next year,' says Anthony Chan, chief economist at JP Morgan Fleming Asset Management. Despite the negative forces, he adds, there is some expectation that second-term presidents are more willing to do what is right rather than what is politically expedient.

The view is not shared by all. Stephen Roach, global chief economist with Morgan Stanley, said that while Bush's re-election might not have any impact on the global economy in the coming year, the President risks widening the deficits if he implements the fiscal stimuli announced during election campaign.

Moreover, the combination of high oil prices and current account deficits could push the world into a recession next year, he warned. 'Oil prices are 65 per cent above the average over the preceding four years,' he said. 'If oil holds at $50 a barrel for over a month or two, that will qualify as a formal oil shock that has a significant recessionary risk for 2005.'

Of all the clouds that hang over the US economy, the potential that foreign, and particularly Asian, investment will cease to fund the deficit is darkest. Economists are already concerned by a recent drop in investment by foreigners in US Treasury bonds and foresee circumstances in which interest rates rise sharply, reducing capital spending and triggering home-price deflation.