May 10, 2004
by Irwin Stelzer
“The economy is on steroids,” an administration official told me last week, before the latest jobs report was released. The April jobs report, released late last week, certainly supported that view. The economy added 288,000 jobs last month, well above the 150,000 that most economists were expecting. The frosting on the cake was an upward revision of the previous month’s report, from 308,000 new jobs to 337,000. If the economy continues this performance, more than two million new jobs will be created by the time voters go to the polls in November.
Bad news for the president’s critics. They say that an economy on steroids might be growing, but it is excessively dependent on an artificial and unhealthy stimulus. The steroids being administered to the economy include a federal deficit that exceeds 4 percent of GDP, a trade deficit running at 5 percent of GDP, derisory interest rates, and tax refunds that are keeping consumers in the shops.
None of these steroids can be taken for long without producing a serious reaction—runaway inflation. The federal deficit will force investors to demand higher, growth-stifling interest rates from a government that will drown in red ink when the ageing baby boomers demand their pensions. The trade deficit is also unsustainable, say the worriers, because foreigners won’t forever accept little bits of paper with pictures of American presidents on them, in return for automobiles, trainers and other goods. They will drive the value of the dollar down, making it worth less and stimulating inflation.
The low interest rates that have fueled consumer and corporate borrowing, and helped share prices to levitate, are also soon to be a thing of the past, as Federal Reserve Board Chairman Alan Greenspan has warned. Rising interest rates will discourage debt-ridden consumers from shopping and buying new homes. Finally, supplies of the final steroid, tax cuts, have been exhausted.
With these artificial stimulants removed, the economy is headed for bad times. To which cynical Republicans reply, “Yeah, but not before the November elections.” More responsible analysts have a different answer: the economy’s strength does not depend on artificial steroids, and the problems that have administration critics in full cry will be corrected without causing much more than a blip in the upward trajectory on which the economy is launched. Interest rates will rise, but not so much as to bring growth below 5 percent.
Consider these facts. The service sector is growing at its fastest rate in seven years; the manufacturing sector is on the rise; profits are growing at double-digit growth rates; consumer confidence is high; new and existing home sales were up by 8.9 percent and 5.7 percent, respectively, in March; and retail sales continue to grow, especially in high-end shops.
Even New York City’s hard-hit economy is recovering. The city’s key financial services companies are scrambling to add staff; restaurants are heavily booked; and for the first time my hotel of choice is fully occupied. On the Fourth of July, ground will be broken for the highest of the towers to replace the two destroyed on September 11, and in August the economy will receive a further fillip when thousands of free-spending Republicans descend on New York to renominate George W. Bush.
This city boomlet cheers the media types who dominate television and print reporting to the nation. With the value of their apartments rising at a London-style rate, and their friends finding jobs, they have turned bullish, and are radiating optimism to the rest of America.
The development that has economy-watchers most worried is the price of oil, which broke the $40 barrier last week. Supplies remain tight as Saudi Arabia continues to shut in some two million barrels per day of potential output, while at the same time hypocritically proclaiming its continued fidelity to a $22-$28 price range. Venezuela’s output is about 500,000 barrels per day below normal levels, and other countries are producing about all they can. Demand, meanwhile, grows as China sucks in imports, Japan returns to sustainable growth, and American motorists remain impervious to soaring gasoline prices. Government sources, which have been predicting that prices will return to the $30 range, are about to retreat from that view, and up their guess to $35.
Add to these price pressures a rising risk premium. Threats to the northern pipeline make it imprudent to count on Iraq to continue exports at current levels of 1.8 million barrels per day. More important, terror attacks in Saudi Arabia have increased uncertainty about the durability of the House of Saud. Should Saudi exports be interrupted by terrorists, prices will certainly soar, even if American forces intervene, as is most likely.
Watching all of these developments with a practiced eye is Federal Reserve Board Chairman Alan Greenspan. He is quite relaxed about consumer debt, pointing out that the spurt of home-buying has reduced consumers’ rent obligations by an amount about equal to the increase in their mortgage payments, while adding substantially to the asset side of consumer balance sheets.
He is also relatively unconcerned about the trade deficit. Last week he told a meeting in Chicago that “history suggests that current account imbalances will be defused with modest risk of disruption.” Unless, of course, protectionists “erode global flexibility”. Only the budget deficit worries him. And with good reason. Congress is fashioning a bill of corporate tax cuts that has executives licking their lips in anticipation of its passage.
In the end, all depends on whether productivity grows at a rate sufficient to offset the rising costs resulting from tightening labor markets, high oil and other commodity prices, and the modest increase in interest rates that is now in the cards. If it does, a 5 percent growth rate should be sustainable without triggering rapid inflation, even if high oil prices shave half-percentage point off of growth.
This article appeared in London’s Sunday Times on May 9, 2004.
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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