Burden that's set to bring down America's economy

AFTER plunging to six-year lows in recent weeks, share prices on both sides of the Atlantic have shown some signs of life in recent days. But does this mean an end to the long drawn-out slump in stock markets that has brought some financial institutions to the brink of disaster, eroded the value of pensions and threatened the global economy ?

For Britain the answer may well be 'probably' - that, at least, is the guarded judgment of Steve Russell, UK equity strategist at HSBC. But for the United States, the aftermath of the dotcom boom and the stock market bubble could still trigger a new share price slump and a double dip recession.

Across the board, private economists have been trimming growth forecasts for the US to between 2% and 3%. Their biggest worry is that the strategy the Federal Reserve has employed to combat recession has run out of steam...worse, it has only been storing up trouble for the future.

As recovery seemed to be taking root earlier this year, it looked as though Fed chairman Alan Greenspan's gamble in slashing interest rates to 41-year lows of only 1.75% in 2001 was paying off. But now the signs are mixed.

On one hand, in the past few days companies such as Citigroup, General Motors and Ford, which are plugged into the US consumer boom, have been reporting big recoveries in third-quarter profits. In response, Wall Street has jumped for joy. Since posting a five-year low of 7286.27 on Wednesday of last week, the Dow Jones Industrial Average has leapt 10.3%.

But others, including Intel, the world's largest computer chip maker and a bellwether for capital spending, have warned this week of tougher times ahead. This has reinforced fears that US share prices, even if they rally for three to six months, will soon be testing their lows again.

'The US economy will disappoint next year as consumers buckle,' said Jason James, global equity strategist at HSBC. 'US share prices are still massively overvalued in terms of historic yardsticks.' He believes the rally will peter out and that US shares could fall 20%, taking the Dow to around 6000. On HSBC currency forecasts, foreign investors would also have to digest a 10% fall in the dollar over the next 12 months.

Behind the fear is the belief that the central bank's strategy of relying so heavily on a housing boom and consumer spending has only been storing up trouble. Since 1998, US house prices have been rocketing, shifting the bursting stock market bubble to property. Prices in hotspots such as Boston and Miami have surged almost 90%.

Just as in Britain, the boom and low rates have sent homeowners scurrying to banks to refinance mortgages and withdraw cash to spend on whatever takes their fancy. In recent months, owners have been borrowing against their homes at an annual rate of $200bn (£130bn) - 2% of gross domestic product. Mortgage rates are now as low as 5% for a 30-year loan for the most creditworthy borrowers.

But plenty of borrowers have been sucked into borrowing at rates two or three times more than this. Now there are signs this mountain of debt is becoming too burdensome. There are also worries that the property price rise has come to an end, removing the prop that has underpinned strong growth in private consumption. The Fed has reported the overall volume of 'sub-standard' and 'weak' bank loans is now $236bn, the highest since 1992.

But the most worrying signs of trouble ahead, as opposed to bankruptcies already recorded, are surfacing in housing. Mortgage lenders are getting nervous. In spite of the low rates, debt service costs, at 14% of household income, are at 20-year highs. A record 1.23% of home loans are now being foreclosed and one in 20 borrowers is falling behind with repayments. Banks are tightening their lending criteria.

Rising unemployment, up from 4% in 2000 to almost 6% now, is also threatening consumer spending. Detailed figures show longterm unemployment has been increasing to recession-like levels. Corporate restructuring, as firms try to compensate for sluggish growth and weak pricing power by cutting back on jobs to boost profits, could push it higher.

Consumer confidence polls have also been weakening of late, stirring memories of Americans' gloomy reaction to the threat of war in the Gulf in 1991. This at a time when there is little evidence of a sustained revival in capital spending by business which could take up some of the slack.

Neal Soss of CSFB said that constantly lowering rates is the only way in which the Fed can sustain the house refinancing boom. Jan Hatzius of Goldman Sachs said consumers are 'living on borrowed time' and that even if house prices just stabilise, rather than plummet, consumption will weaken.

The biggest worry, however, is that since the mid-1990s, US consumers have fuelled global growth. If they really are running out of puff, the shock will be felt worldwide.