March 31, 2003
by Irwin Stelzer
Imagine that it is Day One in the post-Saddam era. The war is over save for the mopping up of a few irregulars, the tyrant has been “dealt with,” to use military lingo, and Jacques Chirac is leading a charge in the United Nations to wrest control of the reconstruction process from the Americans and Brits who liberated Iraq while France provided Saddam with moral and material support.
In Washington, the Federal Reserve Board’s monetary policy gurus can no longer credibly contend that the fog of war so obscures the economic outlook that they have no idea what course to take, and President Bush has found time to introduce himself to the economic policy team he hastily assembled after the night of the long knives, when he replaced his secretary of Treasury and chief economic adviser.
The Fed and the White House economic experts are likely to see the following as they gaze into their crystal balls. Oil prices will be easing: Saddam did not destroy Iraq’s ability to resume and eventually increase oil production, Venezuela is gradually increasing its output, and the Saudis for once have been telling the truth when they promised to keep supplies flowing. The net effect is an economic stimulus about equal in force to the one the president hopes to get from his proposed tax cuts.
Despite a short uptick at war’s end, the dollar will be weakening. That should help American manufacturers by providing a bit of stimulus to exports and a drag on imports, although an on-going recession in over-regulated, over-taxed Germany, and the insistence by the Chinese authorities on pegging the renminbi to the dollar will dilute the stimulative effect of the dollar’s decline.
The housing market will continue to provide the economy with some upward momentum. Although the two “w’s”, war and weather, reduced sales of existing homes by 4.3 percent in February (new home sales dropped a stunning 37 percent in the storm-racked Northeast), the market is already showing signs of a quick snap-back. Applications for new mortgages continue to flood lenders; interest rates remain low, keeping houses affordable; and increasingly affluent immigrants are swelling the ranks of first-time buyers.
But the seers in the White House and at the Fed will notice that consumers, nervous about job prospects, are intent on continuing to improve their balance sheets. They have already raised their savings rate from around 1 percent to over 4 percent, and are showing some signs of reining in spending, especially on new autos—a good argument for a stimulus package focused on increasing consumer purchasing power.
Which is why the president will, at war’s end, increase his lobbying for his ten-year, $726 billion tax-cut package. He won’t get all he wants. The House of Representatives has gone along with him, but the Senate has cut his request in half. The best guess is that when the two houses of Congress meet to reconcile their views, they will split the difference, and approve something like a $500 billion cut in Americans’ tax burden. But that is only the beginning of the story.
The president wants the reductions devoted to ending what he calls the double taxation of dividends. His political team is telling him that America’s share-holding class is now large enough to swing the 2004 election in his favor if share prices are moving up. Cut the tax on dividends, drive up share prices, and return to the White House for the second term that eluded his father. So say the politicians.
Most economists have a different view. They say that what is needed is a demand-side stimulus: more money in the pockets of consumers so that they can continue to keep the economy moving until they have sopped up enough excess capacity to encourage major companies to resume investing in new plant and equipment. So cut payroll taxes to put money into the pockets of lower- and middle-income consumers, and watch the economy grow while settling into the Oval Office for a long stay. So many economists are advising the president.
The likely outcome is the inevitable Washington compromise—some tax relief for dividend recipients, some for wage earners. The result will be mounting budget deficits that create a problem for the president’s economic team. His secretary of the Treasury, John Snow, opposed large deficits before he gave up the candor allowed in the private sector for the circumlocution required of cabinet officers. So did chief White House economic adviser Stephen Friedman when at Goldman Sachs. And the new chairman of the president’s Council of Economic Advisers, Gregory Mankiw, became a millionaire from the sales of a textbook in which he argues that “expansionary fiscal policy raises the interest rate and thereby reduces investment spending”—the “crowding-out effect” of public spending that Bushites deny exists.
Bush has persuaded the members of his troika to fall into line—White House passes are a treasured item here in Washington—and whatever its final form, there will be a fiscal stimulus. Which puts the ball in the court of that famed octogenarian tennis fanatic, Fed chairman Alan Greenspan.
The Fed can, if it chooses, offset the crowding-out effect by intervening in government bond markets to drive down long-term interest rates, something it has so far been reluctant to do. That might get businessmen out of their bunkers.
If consumer demand remains strong enough to make a dent in the excess capacity that is afflicting many industries, a weaker dollar improves the competitive position of U.S. manufacturers, and obsolescing equipment forces spending on new gear, executives will start signing the spending authorizations that have been piling up in their in-boxes.
We Americans are spoiled. Last year the economy managed a respectable growth rate of 2.4 percent, in the face of fears about terrorism, an impending war, a troubled stock market, and corporate scandals. Yet television watchers and readers of the financial press can be forgiven if they have the impression that the United States was experiencing a major recession. It wasn’t. And won’t. Slow growth, perhaps. But nothing worse.
This article appeared in London’s Sunday Times on March 30, 2003.
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.
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