What's Next: 4 Big Predictions for the U.S. Economy

Last Updated Jul 9, 2009 4:27 PM EDT

It's hard now to recall how smug we once felt about the U.S. economy. Blessed with a flexible workforce and relatively unburdened by regulation, America was more dynamic than other developed nations, and that's why it was growing faster. Our technology sector led the world, Wall Street housed the globe's most creative financial wizards, and our indefatigable consumers bore the rest of the world's economy on their free-spending shoulders. Our bankers and economists jetted about lecturing other nations on how to run their finances. Sure, we bore a bit more risk than citizens of softer countries, especially in Europe, but we could take it. We were Americans. Besides, under Chairman Greenspan, the Federal Reserve had licked the business cycle, so there wasn't really anything to worry about.

Things look a bit different now. Our financial sector has been exposed as a sham, GM is bankrupt, unemployment is heading toward 10 percent, and American-style capitalism is blamed for the global economic meltdown. Looking down the line, our mounting deficits threaten to dethrone the dollar as the world’s leading currency and our economic growth is widely forecast to slow. Meanwhile, China owns more than $1 trillion in U.S. debt and grows twice as fast in a bad year as the U.S. grows in a great one. Heck, China even won more gold medals than the U.S. at the Olympics.

All of this is true; and yet it is not the whole story. The economy will pull out of this downturn as it always does; the process may have already begun. Yes, things have changed — in some ways quite possibly for the better. The environment in which you have to build your fortune and your career will be very different from what you may have expected just a few years ago. Here are a few ways to think about the world as it is likely to look in 2020.

The United States will still be top dog, but a smaller one.

It was inevitable, perhaps. But although our dominance over the world will shrink, the U.S. will remain the global economy’s alpha dog. And outside of the possible blow to your national pride, the economy’s smaller margin of influence won’t, by itself, cause any damage to your own financial security.

Let’s start with the numbers. The U.S., with a gross domestic product of $14.2 trillion, is more than three times the size of the next biggest economy (Japan, $4.3 trillion), and produces $10 trillion more than China’s 1.3 billion people ($4.2 trillion).

In short, any challenger has a lot of ground to make up — and no one can close the gap in the next 10 years, at the very least. “It’s hard to see any set of circumstances where China could actually outpace the U.S. in the next decade,” says Hamish McRae, economics columnist at The Independent newspaper in London and author of The World in 2020: Power, Culture and Prosperity. “It’s almost inconceivable.” The math is compelling: If China grows 10 percent between now and 2020 and the U.S. grows 2.5 percent, the U.S. would still be a third bigger.

As for Europe, the 27 nations of the European Union combined have a bigger GDP than the U.S., but it makes sense to see Europe as Europeans do — as countries first. Germany has the biggest economy, with $3.8 trillion in GDP, growing in the low single digits. It is never going to catch up with China again, much less the U.S.

That’s the numeric case. But there are other ways of exerting leadership, and in these too, China is not yet playing in the major leagues. For example, among the top-30 global brands, it has only two — China Mobile and ICBC, neither of which has real traction beyond its massive home market. The U.S. has 20.

What about competitiveness? Again, the U.S. has a huge lead. According to the World Economic Forum, the U.S. is the world’s most competitive economy, with particular strengths in entrepreneurship, innovation, and research and development. China is 30th,just ahead of the United Arab Emirates.

The dollar, despite its problems, remains the global reserve currency, meaning that the greenback is the preferred means of exchange in international transactions. The euro faces enormous political pressures, and the pound and the yen are too small. The yuan, which is systematically undervalued and not freely convertible, is no one’s choice for the role of reserve currency.

“I expect we will move eventually to a multicurrency world,” concludes McRae. “But if the U.S. is still the world’s largest economy, the dollar will be the most important single currency.” That is a change, not a disaster.

The same is true for U.S. leadership in general. The degree of dominance will diminish, but not disappear. Think of it this way: The U.S. was probably at the pinnacle of its political, economic, and cultural clout around 1950, when it accounted for more than half of global GDP. But in 1950, the rest of the world was a mess. China had just finished the civil war that brought the communists to power, and Europe and Japan were digging out, literally, of the carnage of World War II. Now the U.S. accounts for about 24 percent of world GDP. It is a smaller presence on a more prosperous block — and it’s hard to see what’s wrong with that.

Take Action: Hitch your portfolio to global growth by diversifying your savings around the globe. But use moderation: Don’t plow your life savings into the Shanghai Stock Exchange. China’s stock markets are as much casino as capital-raising machines, with volatility to match.

Your taxes will rise.

Here are three words you will not hear President Obama (or his successor) say: “No new taxes.” There will be more taxes; there does not appear to be any other option. Whether the Paulson-Obama-Bernanke-Geithner stimulus plans will work is unknown, but what is certain is that they have to be paid for. The Congressional Budget Office says the national debt is approximately 82 percent of GDP, and the administration’s own projections see that figure rising to 100 percent.

Couldn’t we grow fast enough to pay down debt without raising taxes? Not likely. Money that is being used to service debt or pay entitlements like Social Security and Medicare cannot be used to create new jobs or launch businesses. And if Congress imposes more costs on business in the name of fairness or the environment or because it’s a day of the week ending with “y,” then growth will slow more.

From 1987 to 2007, the nation’s economic output expanded at about 3 percent a year. But we now face headwinds that make that rate look unsustainable. First of all, 71 percent of GDP is powered by consumers who have been spending more than they earned for years, and that can’t continue. As bond investor Bill Gross observed in a recent speech, the national inclination was to shop till we dropped, and “we finally did drop.” While consumers were loading up their credit cards, the financial sector was boosting earnings by leveraging its bets 30 to 1. Now the great deleveraging has begun, and investment banks have converted to bank holding companies with stricter capital requirements that will limit their ability to goose earnings.

Another goose to earnings (and a rising stock market) was falling interest rates — 10-year notes yielded nearly 15 percent in 1982; today they are less than 4 percent. Mathematically, that can’t repeat. And given the growth in our national debt, some economists fear we could be headed in the other direction.

Moreover, there’s reason to believe that productivity, another key driver of growth, will suffer. Robert Gordon of Northwestern University has broken down productivity since 1987; for most of that period, he found, productivity grew at 1.3 percent a year. The exception was 1997 to 2004, when the effects of information technology investment caused a temporary surge of 2.4 percent.

Is there a breakthrough on the horizon that will transform the world as much as the IT revolution did? Maybe, but such breakthroughs are probably a once-in-a-generation phenomenon. So if you start with an assumption of 1.3 percent productivity growth, add 1 percent for population growth, and then a little bump for innovation, that comes out to 2.5 percent.

Take Action: When taxes climb, the value of tax breaks goes up. Consider municipal bonds, especially if you live in a high-tax state. Yields are juicy thanks to credit concerns. (Of course, those concerns may prove justified, so don’t bet the farm). In a high-tax world, the Roth IRA looks more attractive than ever, and in 2010 you can convert to a Roth regardless of your income level. And if college tuition bills are in your future, open a 529 plan. Even if your children are already college-bound, you may be able to get a state tax deduction by simply parking your cash in the account for a short time before paying the bill.

Unemployment will settle at a higher rate.

Americans, the stereotype goes, have short memories. This can be a good thing; it is one reason, for example, that so many great American entrepreneurs have shrugged off one (or two) bankruptcies to try again. But the hangover from this recession will be felt for years in the job market.

At 9.4 percent and climbing, the unemployment rate is higher than it’s been in a quarter century. This follows the unusual period from 1997 to 2007, when the annual rate averaged 4.9 percent. The new normal will be much higher. “We’d better get used to 7 to 8 percent unemployment for years to come,” Gross said recently. “We are just not going to be able to put all these real estate workers, investment managers, and Wall Street types back to productive work.” One could debate whether those investment managers were actually doing productive work, but what is not debatable is the link between growth and unemployment. Slower GDP growth means slower employment growth. And, importantly, financial workers account for less than 10 percent of total job losses. The people who have been really hammered in this downturn are lower on the economic food chain — factory workers, retail clerks, and young job seekers.

What’s more, until the housing market recovers, people who might have moved to find work are going to feel stuck. If you live in Las Vegas and your home is worth half what you bought it for, you are going to be reluctant to pick up and move. At some point, the housing market will head north again, in the meantime, though, many people will not be able to go where the jobs are.

Take Action: While the collapse of the real estate market makes this a good time to be a buyer, ask yourself if renting for a while longer might make sense. If you are a young professional, don’t rush to buy. Owning a hard-to-sell (or rent) property can be a career-killer if you can’t pull up stakes for the next great job.

$2.50 gas will seem like a bargain.

Less than a year ago, oil hit $147 a barrel and prices at the pump closed in on $5 per gallon. That was enough to keep Americans off the road; collectively we drove tens of billions fewer miles. Great for the environment; not so nice for grandparents who didn’t get to see their little darlings. When the global economic downturn hit, the price of a barrel bottomed at $32 and is now about $70.

There was a simple reason oil got so expensive: supply and demand, juiced by a little speculation. The price rose alongside demand in fast-growing countries such as India and China, and it probably got a little ahead of itself as the market anticipated future growth. Last year, as the wheels of cars and commerce stopped turning, global consumption of oil actually fell, and it could do so again this year.

But that is in the context of the Great Recession, an economic slump of singular ugliness. Look longer term, and consumption can only go in one direction: up. Consider that India has now come out with the world’s cheapest car (the $2,500 Tata) and that hundreds of millions of Chinese are at or near the economic point at which car ownership becomes possible.

But production will not keep pace. Given the credit squeeze and reduced profits at oil companies, the International Energy Agency figures investment in oil projects will fall 20 percent this year. Less exploration translates into less supply down the line. And there’s a bigger supply issue: Production of oil has been exceeding discoveries for nearly 30 years, according to analysts at FPA Capital.

Take Action: Your goal is twofold. Put yourself in a position to benefit as much as possible from an expensive energy future while insulating yourself from the cost. On the investment side, consider that shares in energy companies have fallen along with the price of oil, and they look attractive right now.

On the expense side, now is as good a time as any to trade in your Durango for a more fuel-efficient vehicle. It’s a buyer’s market, to say the least, at car dealerships these days. If your home is heated by oil, consider retrofitting it for natural gas. It will not be cheap, but oil won’t be either, and a high-efficiency gas furnace should boost your resale value. If you are building new, build green — the higher construction costs will pay for themselves.

If only the rest of the economy adhered to that rule.

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