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Suddenly, the U.S. Is Where the Optimism Is


Taxes stay low, money floods the market, animal spirits revive

The battle to extend the Bush-era tax cuts was politically divisive, and the process agonizingly prolonged. Yet the decision to continue the cuts—and throw in a few others—is already producing something the U.S. economy needs: optimism. While U.S. growth has accelerated in recent months, the tax deal, signed into law in December, has suddenly made economists, consumers, and companies such as General Electric (GE) more confident about 2011. "That deal was measurably better than I had anticipated," says Mark Zandi, chief economist for Moody's Analytics (MCO). "I feel sentiment shifting. It feels like business is ready to turn the light switch on."

The change in sentiment is all the more striking when compared with the rest of the world. Europe is stuck in its sovereign-debt morass, while China, India, and other emerging countries struggle to cap a rise in inflation. "The new, new, new normal is for the U.S. to be looking in pretty good shape," says Jim O'Neill, the London-based chairman of Goldman Sachs Asset Management. It's "raising issues about the whole allocation of capital between so-called emerging markets and the U.S.," says O'Neill, who popularized investing in emerging markets by coining the BRIC moniker for Brazil, Russia, India, and China.

The Standard & Poor's 500-stock index of U.S. stocks was up 12.8 percent for the year as of Dec. 28, vs. declines in emerging markets such as China and Brazil. It also exceeded the gains in the MSCI World Index, which tracks developed-nation equities. U.S. chief executives polled in the fourth quarter by the Business Roundtable were the most optimistic they've been in almost five years. Jeffrey R. Immelt, chief executive officer of GE, called President Barack Obama's tax cut and his Dec. 15 meeting with corporate leaders "real positives." Executives were pleasantly surprised that the budget deal included a temporary decrease in payroll taxes and a tax break for business investment.

Even long-time bears are getting more upbeat. Goldman Sachs (GS) chief U.S. economist Jan Hatzius has lifted his 2011 forecast to 3.4 percent from 2 percent to take account of the fiscal agreement and a spate of stronger-than-expected economic statistics.

Mohamed A. El-Erian, chief executive officer of Pimco in Newport Beach, Calif., says the stimulus should help the U.S. expand by 3 percent to 3.5 percent in the fourth quarter of 2011 year over year. El-Erian previously predicted growth of 2 percent to 2.5 percent.

Yet there are limits to how much fiscal and monetary stimulus can achieve, El-Erian cautions. He points to the rise in long-term interest rates since Obama unveiled his $858 billion tax-cut compromise with Republicans, a sign that bond buyers, long unconcerned about the U.S. deficit, may be starting to worry. The yield on the Treasury's 10-year note was 3.48 percent on Dec. 28, according to Bloomberg data, compared with 2.92 percent on Dec. 6, the day the alternative tax deal was announced.

The outlook for 2011 is taking shape as many governments and central banks shift away from the united approach of easier fiscal and monetary policies they had used to tackle the recession and its aftermath and begin to work more in their own self-interest. In the U.S., for example, the Federal Reserve has embarked on its second round of so-called quantitative easing (QE) with a plan to buy $600 billion of long-term Treasury securities through June.

The Fed's actions are designed to make credit more available in the U.S. and stoke a recovery. Yet a chunk of that money will end up invested in emerging markets, which are struggling already to absorb billions in foreign capital, contain inflation, and keep their currencies competitive. The reluctance of China and other emerging-market economies to rein in growth too much is boosting demand for commodities and jacking up the cost of energy worldwide, including in the U.S. "Unintentionally, QE2 is leading to a fragmentation of global financial markets, because each country takes actions to protect itself," Nobel laureate Joseph E. Stiglitz, an economics professor at Columbia University, said at a seminar in Santiago, Chile, on Dec. 10.

November's 5.1 percent annual gain in China's consumer prices was the largest since July 2008, and people there are more concerned about rising costs than at any time in the past decade, according to the People's Bank of China, the country's central bank. The PBOC raised benchmark interest rates for the second time in three months on Dec. 26, to 5.81 percent for loans and 2.75 percent for deposits. Prices in Brazil rose by 0.83 percent in November from the prior month, the most since April 2005.

In the U.S., sustaining the economic momentum is the priority for now, not tamping down inflation. "Policymakers are going to keep on running into each other," says Stephen King, chief economist at HSBC (HBC) Holdings in London and a former U.K. Treasury official. The result will be a "very uneasy, very uncertain" world.

The bottom line: While the U.S. economy may prove surprisingly strong in 2011, the cost of that growth could be increased friction with other countries.

Miller is a reporter for Bloomberg News. Kennedy is a reporter for Bloomberg News.

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