U.S. Economy Benefits from Benign Neglect
July 1, 2002
by Irwin Stelzer
The Fed met and decided to do nothing. OPEC met and decided to do nothing. The president’s top economic team met and decided to do nothing. The leaders of the world’s industrialized countries met, and, well you get the picture. On the assumption that we are best served when the interdiction “first, do no harm” is honored, this serial inactivity may be in the best interests of the American economy.
Consider the alternative. The Federal Reserve Board’s monetary policy committee, by deciding to leave interest rates unchanged, refused to heed the pleas of those who wanted rates raised to shore up the dollar, and of those who were pressing for a further cut to stimulate the economy. An increase might have aborted the recovery, and a reduction might have spooked financial markets by suggesting that the Fed feared a double dip recession.
OPEC, the oil cartel, also did nothing, thereby ignoring the price hawks who were pressing for a price increase to offset the decline in the value of the dollars oil producers are receiving for their crude oil. Indeed, cheating on quotas is now making significant quantities of new oil available to consumers, and the cartel is hinting that it may increase output at its September meeting. A production cutback and an increase in energy costs would have been inconvenient in the extreme for the recovering U.S. economy, and assurance of stability is a definite plus.
And the heads of state, beset by the policy paralysis that is the saving grace of all such meetings, refused to take coordinated action to intervene in currency markets to shore up the dollar. Had they decided to do so, and succeeded, they would have prevented the gradual reduction of America’s record trade deficit that a weakening dollar will eventually produce.
This benign neglect means that policy makers declined to add to the harm done by the collapse of WorldCom, which added to the understandable reluctance of investors to entrust their savings to the equity markets. The uncertain outlook for future profits is bad enough, but add to that the dawning realization that past profits, duly recorded on the books and certified as real by auditors, were mere smoke and mirrors, and you have an invitation to stay away from shares. Or at least shares of American companies.
So investors are either putting their money into houses, producing a record wave of new construction and sales, or into investments overseas. Money managers have been nervous about the U.S. markets for several months. Almost two-thirds of a group of fund managers that oversee more than $711 billion in clients’ money say the U.S. has less favorable prospects and more volatile and less transparent earnings than Europe, the U.K. or emerging markets. Deutsche Bank’s mutual fund unit is typical: it has reduced the portion of its worldwide equity portfolio that is invested in the U.S. from 43 percent at the beginning of this year to 35 percent.
With the dollar declining, that move from American equities is likely to continue. As is the dollar slide. It is less fashionable since September 11 to refer to the government deficit and the trade deficit as “the twin towers.” But the president’s unwillingness to control congressional handouts to everyone from ailing pensioners to healthy farmers, and consumers’ appetites for imported goods (the April trade deficit of almost $36 billion was a record) are combining to make investors nervous about holding dollars that seem to be depreciating in value daily.
But despite the WorldCom wipeout, the dollar drop, and the volatility of share prices, these are hardly the worst of times for the U.S. economy. It would be the unwise seer, indeed, who ignores the bright spots in the long-term outlook. After all, the economy grew at an annual rate of 6.1 percent in the first quarter, and probably grew at somewhere between close to a still-satisfactory three percent in the quarter that ends today, despite all of the widely heralded problems. And jobless claims fell for the ninth consecutive time last week.
The weakening dollar should stimulate exports and direct more of consumer spending towards made-in-the-U.S.A products, helping to sop up domestic excess capacity, thereby stimulating a much-needed increase in investment. Consumers, although not as cheery as they were a few months ago, nor as willing to crowd into the nation’s malls and shops, are still spending enough, and snapping up homes at a fast enough rate, to prop up the economy. With the 30-year mortgage rate at 6.63 percent, close to an all-time low, and the value of homes rising at a record rate, consumers will continue to extract the new equity from their homes by “mortgaging out”. This will give them tens, perhaps hundreds of billions more to spend.
Add to that a rise in spending on capital goods. Late last week the Commerce Department reported that orders for non-military capital goods rose in May at the fastest rate since the end of last year. Military spending will also start increasing as the money being committed to the war on terror finds its way into the system. The manufacturing sector, long in the doldrums, is showing signs of recovering.
Most important, inflation remains nil. Even the decline in the dollar, which will make imports more expensive and eases competitive pressures on domestic producers, is not likely to unleash inflationary pressures sufficient to force the Fed to raise interest rates before the recovery takes solid hold. Finally, productivity, perhaps the most important factor in the long-run health of the economy, continues its steady advance.
None of this means that there is clear sailing ahead. The administration’s ability to calm the stock and currency markets is seriously weakened by the low regard in which treasury secretary Paul O’Neill is held by Wall Street. Bill Clinton could always send his Treasury secretary, Bob Rubin, to the Treasury steps for a calming press conference. O’Neill carries no such weight. But Bush might just get lucky, and the dollar slide won’t turn into a rout, giving him time to decide how to strengthen his economic team.
This article originally appeared in London’s Sunday Times on June 30, 2002, and is reprinted with permission.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.