From October 12, 2008 Sunday Times (London)
October 14, 2008
by Irwin Stelzer
The politicians are now running full tilt to get ahead of the markets. So far, the markets are winning, plunging in what to all appearances is a death spiral.
Share prices fall, making it nearly impossible for the banks to raise new capital; house prices fall, reducing the value of the mortgage-backed securities on bank balance sheets; governments offer to help by buying preference shares in the banks, but the claims these would have on future earnings scare common shareholders and share prices fall further.
Not that the policymakers have been idle. Led by Gordon Brown, they are now about to shore up the capital of the big banks, to increase their ability to lend.
Meanwhile, Hank Paulson and his US Treasury team are about to take $700 billion (£412 billion) of dicey loans from the banks and replace them with good hard cash. Throw in the fact that the world’s central banks finally decided that Federal Reserve Board chairman Ben Bernanke had it right by keeping interest rates low, and that Bank of England governor Mervyn King and European Central Bank president Jean-Claude Trichet have been wrong to keep rates high, and you have a policy mix that should break the credit logjam.
Two problems. First, these policy remedies will not take effect immediately. In America, Paulson and his team have to find some way of valuing the bank assets they plan to buy, and hire experts to conduct the sales. In Britain, bankers are not sure that they want to avail themselves of the up to £50 billion Brown is offering in exchange for control over their compensation and some of their operations.
Second, and more important, a worldwide recession looms, with the US not immune from its consequences. The travails of the nation’s housing industry have been too fully reported to need comment here.
Nine consecutive months of job losses have cut the number of jobs in the nonfarm sector by 760,000 so far this year. Jobless claims are at their highest since 2001 and it is taking longer for the unemployed to find new work. Orders for manufactured goods are falling at an accelerating rate, and a leading index of manufacturing activity records the lowest level since the days following the September 11 terrorist attacks on America. Car sales are so low there are serious doubts about the ability of General Motors to survive the downturn, despite a $25 billion government handout to the industry to help it convert to greener vehicles.
Little wonder consumer sentiment is dropping, a situation that will worsen when millions begin receiving reports, now in the mail, of the third-quarter performance of their pension plans.
Goldman Sachs economists estimate that consumer spending, adjusted for inflation, will decline in the current quarter for the first time since 1991. That is a frightening prospect for all save Wal-Mart. Its sales are growing at an annual rate of close to 3% as consumers switch from higher-priced competitors.
One last note of gloom: exports, which had shored up the otherwise weak economy, are unlikely to sustain their recent rapid growth. The global recession and the continuing strength of the dollar will cut into overseas demand.
It takes a pair of rose-coloured glasses to see any sign of cheer in this dark, dark picture. Fortunately, I am the possessor of just such lenses. Start with the fact that the steps taken by policymakers have not had time to work their way through. Just because the immediate reaction of markets was less than enthusiastic does not mean that, given time, unleashing a flood of government cash into the banking system will fail to unfreeze credit markets.
Although the number of companies that might default on their debt is at a five-year high, the corporate sector as a whole is awash with cash. Holdings of cash and short-term securities by companies included in Standard & Poor’s 500 index (excluding utilities and financial institutions) stand at a record $648 billion. Fred Smith, chief executive of Fedex, told the Financial Times: “With the exception of the autos and housing, there’s a lot of cash flow . . . in the industrial sector.”
Even the housing industry is showing faint signs of bottoming out. The pace of price declines is slowing, from an annual rate of 25% to 10%. Inventories of unsold homes, although still high, seem to be coming down a bit, as lower prices attract buyers. The August index of pending home sales is at its highest level since June 2007.
The service sector continues to hold up surprisingly well. The index of nonmanufacturing activity remains above the 50 mark, and new orders are up marginally, which means that sector is at least stable and possibly expanding, although jobs are being cut.
More important are longer-term indicators. America’s states and localities have become deft at offering incentives to foreign firms to set up shop there. A Financial Times informal poll of leading foreign executives shows that rising labour costs in Asia, plus offers of infrastructure construction to accommodate new manufacturing facilities, make the US the world’s low-cost manufacturing site.
But such incentives are not the fundamental basis of America’s competitive advantage. The World Economic Forum, which ranks countries based on the quality of education, labour-market flexibility, financial-market sophistication and other criteria, ranks the US No 1 in global competitiveness.
That explains America’s rising productivity, its lead in creating high-tech companies and in keeping structural unemployment at low levels, and its ability to recover rapidly from periods of recession or below-trend growth.
Life might not now be “one long jubilee”, to borrow from songwriter Ira Gershwin, but we at least know the answer to the question he put in that same work: “Who cares what banks fail in Yonkers?”
Policymakers from Washington to Brussels to Beijing care, and care enough to throw billions of dollars, pounds, euros and other currencies at banks and businesses to show that they do. With luck, that will restore confidence to financial markets.
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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