Why Do We Feel Bad If Things Are So Good?
From the April 22, Sunday Times
April 23, 2007
by Irwin Stelzer
Share prices are hitting record highs; corporate profits are coming in at what only the greedy would consider unsatisfactory levels; jobs are plentiful; real wages are rising — yet six out of every ten Americans are expecting a recession.
The economy added 180,000 new jobs in March. The service sector, which accounts for more than 80% of all payrolls, continues to grow, fuelled by the healthcare, information services and hospitality industries. After 43 consecutive months of job gains, during which the economy added 7.8m new jobs, the unemployment rate is down to a virtually irreducible 4.4%, despite the loss of more than 100,000 jobs in the residential construction industry. Household incomes are rising well above the reported rate of inflation.
But Americans worry nevertheless. Difficulties in Iraq are souring the national mood, and Americans can no longer cheer themselves up by regaling their dinner companions with tales of the latest increase in the value of their homes. Then, there is a general feeling that foreign competition is putting every job at risk, a view exacerbated by press reports of layoffs by large firms while hirings, concentrated in smaller firms, go unreported.
Finally, there is the matter of inflation. Where you stand often depends on where you sit. Ben Bernanke, Federal Reserve Board chairman, sits on the Fed’s monetary policy committee, and he looks to the overall inflation rate as one of the guides to interest-rate policy. He is pleased with the data showing inflation to be close to nil.
But many consumers sit not in the Fed boardroom, but in the driver’s seats of their SUVs and other vehicles. They pay less attention to the overall inflation rate than to petrol prices, which they confront daily. Price have jumped more than 10% in the past month alone, and at an annualised rate of over 20% in the first quarter of the year. With prices above $3 per US gallon in many areas (40p per litre), consumers just don’t believe that inflation is not a problem, and feel more beleaguered than they in fact are.
Despite all these worries, the very same consumers who say they fear a recession also say their own personal finances are very secure or fairly secure. So perhaps it is best to ignore those polls. After all, despite all the recession fears, retail sales in March were 3.8% above year-earlier levels, suggesting that even nervous consumers continue to find relaxation in the nation’s shops.
Still, there is little question that the American economy is slowing. The debate about the outlook for the housing sector is now between those who are predicting a collapse, and those who say they see light at the end of the tunnel — but that “light” is merely a bottoming out. Almost nobody is predicting an upturn.
Of course, not all housing markets are equally hit by the current combination of rising inventories of unsold houses, falling prices, and increasing difficulties in the mortgage market. Donald Trump, the celebrity builder famed for his glitzy properties and brutal manner of firing potential apprentices, says that Chicago, New York, Los Angeles and “most cities are doing very well at the very high end of the market”.
But that’s little comfort to builders looking for buyers who are not considering taking up residence in super-pricey Trump Tower. The number of housing starts last month was 26% lower than last year, and some respected analysts are predicting a 40% drop in average home prices before the market stabilises. Add problems in the mortgage market as lenders over-react to problems in the sub-prime sector, and it is little wonder that Goldman Sachs reports that “builders’ sentiment worsened in April from an already low level”.
Indeed, the question of whether the economy will continue to grow at a moderate rate, or slip into recession, comes down to whether the problems in the housing sector will spill over into the economy as a whole. If consumers have to rein in spending because they are no longer able to withdraw equity from their homes, or if the number of jobs lost in construction overwhelms gains in the service sector, the expected return to 3% growth by year-end will prove unattainable.
In that case, all eyes will be on the Federal Reserve Board’s monetary policy committee, which will be under pressure to cut interest rates. Bernanke, however, is impervious to the sort of pressure brought by whingeing businessmen and panicky politicians.
He has to worry about the inflationary effect of the falling dollar, which drives up the cost of imports and relieves some of the pressure on domestic manufacturers to keep prices down so as to meet foreign competition.
And that decline seems set to continue, precluding an interest-rate cut soon. Meanwhile, higher inflation in Britain and the EU will force the Bank of England and the European Central Bank to move rates up. That increases the attractiveness of non-dollar assets. Add the decision of some central banks to lighten up on their dollar holdings, and America’s persistent trade deficit, and you have a prescription for a further drop in the dollar. A $2.25 pound and a $1.45 or higher euro might well be in our future.
Which might be good news, although not for Europe’s manufacturers. Exporters will find it tougher to sell in the United States as prices of made-in-Europe goods rise in America, and European firms catering to their domestic markets will find their customers increasingly attracted to made-in-the-US products. The world has been calling on spendthrift Americans to rein in their spending to reduce what are called “imbalances”. That’s just what will happen, proving once again that you should be careful what you wish for.
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.