US consumers will keep the world afloat
October 26, 1998
by Irwin Stelzer
GOOD NEWS is hard to find these days. Russia is heading for hyperinflation and the bad old days of state control of the economy. Britain is on the brink of recession. Analysts are cutting their growth forecasts for most European countries.
In Asia, Japan is in recession, its political process too paralysed to get its banking system back on track. Malaysia has seceded from the international market system and arrested advocates of market capitalism. Indonesia is threatening to introduce foreign-exchange controls. Hong Kong's government is desperately trying to maintain its peg with the dollar. And China's promise not to devalue its currency runs out at the end of the year.
In Latin America, Brazil is running a government deficit equal to 7% of gross domestic product, as a result of which capital is fleeing and devaluation is around the corner. The Mexican peso has fallen 25% against the dollar this year, despite short-term interest rates of about 40%. Even stable Chile is nervous.
Meanwhile, in America the stock market has wiped out about $2 trillion of wealth, the trade deficit is at the highest level since records began and is heading higher still, the profits of America's companies seem to be vanishing before our very eyes, and the nation's president is embroiled in scandal.
Then there is the bad news. The world trading system, which has contributed so much to post-war prosperity by encouraging international division of labour, is under threat. No longer is it assumed that the free flow of capital, goods and services, is an unambiguous good thing. Even the International Monetary Fund (IMF), reeling from its failure to ameliorate the crises that are rolling from one part of the world to another, now says it may not be a bad idea in some circumstances for countries to control the inflow and outflow of capital.
So much for the daily diet of news reports. Dig a little deeper and it turns out that the bad news is not all that bad. Start with the collapse of the rouble and the turmoil in Asia. There can be no denying that these problems are causing enormous hardship, especially as many of these nations have no social safety net. Nor can there be any question that in some cases the economic problems will create political problems. But there is an end game, and it is not a tragic one.
There will be bankruptcies. But the long-term consequences of those purges of the inefficient will be that businesses that were unrealistically valued will be written down to valuations that can be supported by their earnings prospects, and that these assets will pass into stronger hands. That process is already under way, with "bottom-fishers" and sharks prowling Asia for acquisitions that will in the long run add strength to both the acquirers and the acquired.
More important, the enormous misallocation of resources in which capital, labour and other assets were consumed by firms that were cronies of important politicians is coming to an end - or at least is being much reduced. In the long run this means resources will be more efficiently employed, with an increase in productivity and wealth.
Then there are those investors who have woefully underestimated the risks involved in lending to and investing in emerging markets. If governments bail them out, creating what we call "moral hazard", they will learn the wrong lesson - that the profits of risky lending are theirs to keep, while the losses belong to the taxpayers. But the American Congress's refusal to fund the IMF unless it changes its ways, and Helmut Kohl's recent statement that he is unwilling to pour more good D-marks down the rouble rat-hole suggest that taxpayer bail-outs of improvident lenders may become less frequent. So put that on the plus side of the ledger.
Add to that side the fundamentals of the American economy. Everyone who wants to work is working: the unemployment rate is a low 4.5%, real incomes are rising and the economy is creating 200,000 new jobs in a slow month. Inflation is nil and likely to stay that way as competition from imports prevents domestic manufacturers from raising prices. Mortgage applications are at an all-time high. Retail sales continue to increase, as do orders for big-ticket items such as computers and cars.
And consumer confidence remains high, even after recent stock-market losses. The University of Michigan's consumer-sentiment index stands at 100.1. This is a bit below the 104 level reached in August, but well above its post-war average of 85; and only the fourth time since 1960 that the index has reached 100. Since consumers account for about two-thirds of all economic activity in America, this suggests the economy may slow but is unlikely to tip into recession. In short, the world's consumer of last resort is in good health.
Most important, both fiscal and monetary policy tools are fully available to American policymakers. With the budget in surplus, there is room for stimulative tax cuts should the American consumer become stingy. And with nil inflation there is room for a stimulative cut in interest rates, which are high in real terms. So if America's policymakers get it right - and they have done so far - things may turn out better than the gloomy news reports would have you believe.
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.