Sunday Times (London)
October 11, 2009
by Irwin Stelzer
The letter W is back on some agendas, and sending tremors through the business community — especially as it seems to be displacing V in the discourse of economy-watchers.
Recall, the alphabet has been put to the service of economists. A V recovery is one in which a sharp drop is followed by an equally sharp rebound. A U is a drop followed by a period in which the economy bumps along the bottom, and then recovers. An L is worse: a precipitous drop, followed by a long period of stagnation. And the dreaded W is worst of all. The economy plunges, then recovers, luring investors into the market and businessmen into new investments, only to drop again before a final recovery, with substantial losses for the prematurely optimistic.
The optimism engendered by soaring share prices in the quarter just ended came to a screeching halt when the Department of Labor issued a jobs report so grim that the Lindsey Group consultancy warned its clients not to read it “without a bottle of Prozac handy”. Shortly thereafter Ben Bernanke, chairman of the Federal Reserve Board, told a congressional committee that even if the economy grows at a 3% annual rate, the unemployment rate would remain above 9% by the end of 2010. In the view of some observers, he is being optimistic.
A spate of bad news followed. Factory orders down year-on-year by some 20%; a mortgage market functioning only because the government is guaranteeing about 80% of loans written; consumer credit so tight that it is falling at the fastest rate since the crisis began two years ago, and credit increasingly unavailable to small businesses; Treasury secretary Tim Geithner forced to be economical with the truth, lest the dollar collapse, and proclaim that a strong dollar is “very important to this country”; Goldman Sachs predicting that high unemployment will drive down wages and purchasing power.
And that’s only in the short term. Longer term, the position of the dollar as the world’s reserve currency is under threat; America is leading the way towards growth-stifling protectionism; and economic and political power is passing from America to China, India and other emerging nations. Americans are being told to become accustomed to a sharply reduced role in the world.
It all adds up to a W. Or does it? Not certainly. For one thing, the service sector, which accounts for about 80% of American economic activity, has moved into growth territory. The Institute for Supply Management’s index of non-manufacturing activity has passed the 50 mark, meaning that the sector is growing for the first time this year — not by a lot, but growing nevertheless. So is the manufacturing sector, with an index above 50 for the second consecutive month. Equally important, the growth is occurring in 13 of the 18 manufacturing industries covered by the ISM survey.
For another, orders for business equipment are picking up, perhaps because businesses see signs that demand is picking up, and have cash to spend. Business Week reports that non-financial companies have surplus cash flow of $156 billion, “a surfeit that allows companies to finance all of their current outlays for equipment and construction without borrowing”. With the exception of one year, “that is the largest surplus on record”.
Then there is housing. Prices are up, as is the index of pending sales (not yet completed), the latter for the seventh consecutive month. Consumer spending is showing a bit of life, even excluding the temporary jump in car sales arising from the cash-for-clunkers programme that doled out $4,500 of taxpayer money to anyone trading in a gas guzzler for a more fuel-efficient car.
Add to this an easing of credit markets. The default rate of speculative-grade companies has dropped for the first time this year and the premium that riskier corporate borrowers have to pay over safer US Treasuries has fallen by half. “Even cash-strapped companies have been able to refinance,” reports the Financial Times.
Perhaps most important of all is the inventory picture because it is a forerunner of economic activity and the indicator most watched by White House economists. Many companies have so reduced their stocks of materials and goods that they have no choice but to restock. Whether this trend will prove durable, setting off a restocking boom, is difficult to say. Some businessmen tell me it is. Others — these are in the W camp — say it isn’t. In Britain, for example, the Tesco boss Sir Terry Leahy says: “We are past the low point. Things are getting better.” Marks & Spencer’s Sir Stuart Rose doesn’t think so. Nor does America’s Jeff Immelt, chief executive of GE and a W man to his core.
Unfortunately, even if things are improving — and I prefer V for victory to W for worry — the fundamental cause of recent financial problems remains unaddressed. Low interest rates fuelled unsustainable debt. Those low rates were the result of China’s need to make money from the pile of dollars it earns from its exports. It did this by buying Treasury IOUs, keeping their price up and their rates down. China’s exports, in turn, were fuelled by its undervalued currency. That policy remains unchanged. So do trade imbalances. Which means the dollar probably has further to fall if imports to America are to become more expensive, and exports of American products more competitive.
There is no indication that the administration finds a dollar decline undesirable, if it is gradual, despite Geithner’s strong-dollar statement. It is the possibility of a dollar collapse that worries some at the White House. The same fear among investors has triggered a flight to gold. Such a development would force up interest rates, aborting the recovery. Obama has no desire to face the electorate in 2012 with high inflation and interest rates soaring, a real possibility if he adds to the downward pressure on the dollar by increasing the red ink already pouring over the nation’s ledgers, as frightened congressional Democrats are demanding.
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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