A Real Stimulus Would be Victory

This week will begin with President Bush’s State of the Union message to Congress, and end with Tony Blair’s visit to Camp David. Which means that talk of war and its possible economic consequences will dominate the news.

The president will again make his case for disarming Saddam Hussein, whether or not the UN, having just chosen Libya’s Colonel Khadaffi to head its human rights commission, throws its questionable moral force behind him. Blair will sign on, meaning that “war, war” might very soon replace “jaw, jaw.” This has investors nervous, is causing consumers to defer purchases and businessmen to hold back on investments and on inventory building, and is roiling oil markets. Or so we are told by the myriad analysts required to divine the reasons for daily swings in share prices and short-term fluctuations in economic activity.

These seers do, of course, have a point. A protracted war in the Middle East, combined with the continued absence of strife-torn Venezuela from world markets, might drive oil prices well above even current $30+ levels, especially if the OPEC cartel, its press releases to the contrary notwithstanding, continues to refuse to increase production sufficiently to offset the shortfall.

Many observers also lay the decline in the dollar at the feet of the war threat. They have a point: the flight to gold that has driven its price to a five-year high (the spot price in London has risen 40 percent in the past year) is typical of a period in which investors prefer the safety of the tangible metal to the apparent insubstantiality of paper dollars. The result is an exacerbation of the effect of America’s huge trade deficit: a falling dollar that might, just might, raise enough concerns about a renewed bout of inflation to force the Fed to hold off on any further cuts in interest rates, even if the economy fails to dig itself out of the “soft patch” in which Fed chairman Alan Greenspan says it is mired.

The weakening dollar, or the strengthening euro (call it what you will) is also a worry to some. Although Europe’s politicians prefer a strong euro because they see that strength as some sort of evidence that euroland is catching up with the U.S., European manufacturers know that a strong euro, now at a three-and-one-half year high against the dollar, makes it harder for them to peddle their wares in America.

But a closer look at these developments suggests that the threat of a war with Iraq cannot completely explain the gloom that seems so pervasive these days. In the first Gulf War the dollar fell by some 10 percent, and recovered most of its value within a few months. Oil prices rose from around $15 per barrel to about $40 dollars in the autumn of 1990, but fell to $20 and less by the spring of the following year. War may be hell, but for the huge U.S. economy it is a passing phenomenon, especially since policymakers have learned to cope with high oil prices by loosening monetary policy.

In short, it is more than the prospect of war that has economy-watchers worried. Consumers, until now the engine of U.S. economic growth, are showing signs of weariness. Non-auto sales are weakening, and when the boost to spending provided by the latest round of mortgage refinancings has played itself out, America’s consumers might begin to spend less time in the nation’s shopping malls and more time paying down their credit card balances.

Investors see little to cheer about in recent profits reports, even though the vast majority of some 500 companies that have thus far reported have exceeded expectations. But those expectations have been quite modest, and the margin by which reported figures exceed even those expectations is lower than it has traditionally been. For investors, the glass is half empty rather than half full, and they are shifting their funds into low-yielding treasuries (under 4 percent on 10-year treasury bonds).

Perhaps a more important damper than both the prospect of war and the uninspiring earnings reports is the realization that president Bush’s so-called stimulus package, even if passed as proposed—an extremely unlikely prospect—won’t provide much of a stimulus after all. As analysts at Goldman Sachs point out, “A tax cut averaging $36 billion per year over the next decade is quite small in an economy that will produce more than $12 trillion a year.”

The trivial short-term effect of the Bush plan, the likelihood that it will anyhow be watered down by Congress, and continuing fears that the economy is somewhere between stagnant and heading towards the dreaded double dip, are encouraging Washington’s lobbyists to deluge the White House with suggestions for still more tax cuts—faster write-offs, more favorable tax treatment of research and development, and a cut in capital gains taxes head their wish list.

So much for the worriers, focusing as they do on this quarter or the next. They forget that once the uncertainties surrounding the Iraq situation are resolved, oil prices will return to $20 or less. The lower dollar will begin to stimulate exports. The recent declines in unemployment claims should soon be reflected in a drop in the unemployment rate. Corporate cash flow is rising. The leading indicators have been rising for three consecutive months. Productivity increases are continuing, and will inevitably be reflected in an improved profits performance—real, not fictitious profits. Competitive pressures are forcing businesses to invest in obsolescing equipment, so that spending on equipment and software rose by 2 percent after falling by 10 percent in 2001. Real incomes are rising, suggesting that any consumer slowdown will be modest. About the best thing the politicians can do is eliminate uncertainty by getting on with the war, winning it quickly, and opening Iraq’s oil industry to new investment. That would be a real stimulus package.

This article appeared in London’s Sunday Times on January 26, 2003, and is reprinted with permission.