September 27, 2004
by Irwin Stelzer
Early last week a select group was invited to George Soros' posh New York apartment to witness a debate between Richard Holbrooke, assistant secretary of state in the Clinton administration (and a leading candidate for the top State Department job in a Kerry administration), and Bill Kristol, neocon editor of The Weekly Standard. Holbrooke made it clear that the Kerry campaign had made a momentous decision. In the 37 days remaining until voters go to the polls, Kerry will concentrate his fire on President Bush's decision to go to war to depose Saddam Hussein, and on his administration's subsequent handling of the post-invasion situation in Iraq.
That decision means that Kerry has abandoned, or at the very least downgraded in importance, his attacks on the president's handling of the economy. This, despite from-his-hospital-bed advice from the Democrats' most successful vote-getter, Bill Clinton, that Bush's main vulnerability remains "the economy, stupid."
Which suggests that Kerry's economic team, including the well-regarded former treasury secretary, Bob Rubin, is telling him that the economy is improving, and that he might find himself embarrassed by the next spate of economic statistics. For one thing, many economists are convinced that the Department of Commerce will be revising its estimate of second quarter GDP growth from the originally published figure of 2.8% to a more robust figure of close to 3.5%.
Equally important, there are signs that Federal Reserve Board Chairman Alan Greenspan again has it right when he says that "output growth appears to have regained some traction, and labor market conditions have improved modestly," after a temporary "soft patch" due largely to soaring oil prices. Forecasters now expect that higher growth rate to hold in the current quarter, and to accelerate to close to 4% in the final quarter of this year and in 2005.
With reason. Commercial and industrial loans turned up early in the summer, indicating that businesses, which have strengthened their balance sheets, are once again willing to invest and hire: ten of the sixteen hotly contested states added jobs in August. The hard-hit manufacturing sector now has recovered all of the ground it lost in the past four years. Inventory levels are so low relative to sales that businesses are in the process of restocking. Hourly earnings are rising, and consumers continue to surprise on the upside. Inflation remains unthreateningly low: consumer prices rose a mere 0.1% last month, after falling by a similar amount in July.
And the good news is not confined to the United States. Jean-Philippe Cotis, chief economist at the Organization for Economic Co-operation and Development (OECD), reported last week that "the recovery continues to unfold as foreseen, with real GDP set to expand by around 3.5% in 2004…in the six largest OECD economies" (U.S., 4.3%; Japan, 4.4%; Germany 1.7%; France, 2.7%; Italy, 1.3%; UK, 3.4%).
None of this is to say that the long-run prospects for the economy are unambiguously bright. John Makin, a leading economic analyst, points out that even with the huge fiscal stimulus of the tax cuts and the flow of cash from mortgage refinancing, the economy has only managed to grow at an annual rate of 3.5% since the first quarter of 2002. Remove that "extraordinary stimulus," he says, and the growth rate would have been closer to an unsatisfactory 2.0%.
Add to that the facts that the index of leading indicators slipped last week, that the housing market is softening, that "U.S. households [are] living beyond their means," according to a recent report from economists at Goldman Sachs, that the government is doing the same and is awash in red ink, and that the trade deficit is crowding what most economists regard as an unsustainable 6% of GDP, and the next president will inherit a host of problems as well as the Oval Office.
But the time horizon of politicians now extends only 37 days. Longer-run problems such as the trade and budget deficits, the looming drain on pension funds of the retiring baby boomers, and rising health-care costs will just have to wait.
Only the Fed is positioning itself for the longer-run. Greenspan continues to inch interest rates up despite the absence of significant inflation. This is sufficiently reassuring investors to keep long-term interest rates low enough to encourage businesses to step up investment.
Where the Fed goes from here is unclear. The best guess is that it will raise rates again, to 2%, at its November meeting. Some Fed-watchers say that the ratcheting up will halt in December, and that further increases will depend on just how the economy looks when Greenspan leads his colleagues in a review of the economy early in February.
Meanwhile, with Greenspan's term due to expire in January 2006, both the Bush and Kerry teams are starting to compile lists of possible successors. Most of the Democrats' advisors prefer Bob Rubin, whose success as Clinton's treasury secretary and ability to calm the markets during troubled times would be great assets to a Kerry administration. But since Rubin's wife is famously loath to leave New York, and he didn't much enjoy commuting from Washington, it is less than certain that he would accept an appointment. Rubin's refusal would make economist Larry Summers, currently Harvard president and formerly Rubin's successor at the treasury, Kerry's likely choice.
Bush's advisors have made Summers' former teacher, Harvard professor Martin Feldstein, their first choice. Although Greenspan will be a tough act to follow, monetary policy would be in good hands were any of these three to occupy the chairman's seat. Which is more than one can say about the state of fiscal policy in the hands of either presidential candidate, both of whom prefer spending to deficit-reduction.
A version of this article appeared in The Sunday Times (London) on September 26, 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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