This update is originally scheduled to be written after Jan. 27, 2006 when the GDP data of the 4-th quarter of 2005 is released. However, due to the turmoil in stock market in recent days, especially after a big drop of stock prices on Friday, Jan. 20, 2006, many readers probably are anxious about the present status and the future course of US economy. That is why we are writing this update at this moment. As we have been pointing out in earlier updates that US economy may experience an unpleasant surprise at the fourth quarter of 2005 with real GDP growth dropping to 3 % or below, and then the growth rate will stay at that sub par level for the most part of 2006. This view is derived from the movement of Dollar vs. Yen. Dollar had fallen vs. Yen from 2002 to 2004. This fall can be divided into two parts, the first part occurred in 2002, and the second part occurred in the period of the middle of 2003 to the spring of 2004. The first part of the drop of Dollar did not cause the shrinkage of US trade deficit in 2004 because by that time the major source of US trade deficit is coming from China, the currency of which is tightly pegged to US Dollar, so the value of Dollar vs. Yen does not directly affect the imports of consumer goods from China. The surge of consumer goods from China compensated the drop of consumer goods from other Asian countries to keep the total trade deficit in consumer goods rose through 2004. However, the second leg of the drop of Dollar has started to effect both the consumer goods trade and the trade of capital goods in which China still is not a big player. In 2005, US deficit in the trades of consumer goods and capital goods has been flat. The rising total trade deficit in 2005 was the result of the deficit in industrial material and supplies the major part of which consists of the import of oil. Near the end of 2005, the rise of oil price has subsided, and US trade deficit has actually been falling. This behavior of US trade deficit is going to slow down the economic growth well into 2006. However, Dollar has risen vs. Yen and Euro in 2005, whereas Chinese Yuan has only strengthened slightly. This behavior of Dollar will induce a renewed expansion of US trade deficit and thus a moderate push upward of real GDP growth rate in 2007. Considering the rather short time span of the declining growth rate, the coming economic slowdown of 2006 will be mild.
The view of the previous paragraph is based on economic considerations, assuming no non-economic events that will severely influence the economy. More and more economists and financial analysts are gradually embracing this view in recent months. Quite a few important US companies have lowered their performance projections for the coming quarter in the past week, and thus have forced many stock market players to realize the scenario outlined here. If that is the reason of stock market jitter, the unease will not turn into a rout since the economic slowdown is not likely to turn into a real recession. However, there is a serious non-economic danger hanging over that can literally derail the above scenario of a mild economic slowdown. That is the crisis about Iranian nuclear research. Iran has the ambition, the resource and the ability to become a nuclear power. If not interrupted, Iran will own nuclear weapons within a few years, an unacceptable situation for US and Israel. The referral of Iran to UN Security Council probably will not result in an all-out UN sanction, with Russia and China blocking the passage. The effectiveness of a west only sanction against Iran in holding its nuclear ambition is dubious at best. Thus we must embrace the possibility of a military action against Iran by US or by Israel. In the worst case scenario, the military action against Iran may induce Iran to block the shipment of oil from the whole gulf region, the global oil market loses one quarter of its supply, oil price rises to an unforeseeable level, and the mild economic slowdown of US may turn into a full brown global recession. Wall street is suddenly forced to confront this series of possibilities about the Iranian nuclear crisis, and is reacting accordingly, especially after Iran's announcement that it is transferring its foreign currency reserve out of European banks into some undisclosed locations, apparently fearing a western economic sanction. The situation is fluid. If Friday's stock market debacle is indeed related to this Iranian worry, then the dark cloud will linger on for quite a while.