Sunday 4 April 2004

Economic blip

The rapid economic growth in the USA has finally resulted in jobs. Hundreds of thousands of new jobs. Business confidence is the highest in 20 years. The fools.

When this house of cards collapses, remember that I told you so. Two years ago, the American economy could have been saved. Now it is too late. The country was not willing to take the pain of a temporary recession, choosing instead to borrow and spend its way out of the downturn. Record high private borrowing + record high public borrowing = debt trap. When the bills come due, which of them will bail the other out?

The dollar has strengthened, the interest rates are nudging upward as the markets expect the Fed to raise the basic interest rates. I hope Alan Greenspan still has the wits to be very very careful about those rates. Because the economic growth is far less stable than it may seem.

***

The current economic downturn has been long in the making. During the glory years under the Clinton administration, people talked about "the long boom" and predicted that it would last for decades more. Computers and Internet would change society, increasing productivity on a scale not seen since inventions such as electricity and the railroad. There would be more money to everyone, and especially everyone even remotely associated with Internet. As the saying went in those times: "All you have to do is stand on Main Street and shout 'Internet!' and people will come and throw money at you." But as I am sure you have noticed, those days are gone. A bit ironic, since Internet is still spreading and seeing more and more use.

While productivity did indeed grow nicely, people's expectations grew even faster, and they started to borrow toward their future earnings. Then when the dot-com bubble burst, Federal Reserve slashed interest rates drastically. This made it easy to sit on the large loans from the boom. It also caused property prices to rise rapidly, especially housing. The rising prices made home owners feel wealthy, and economists exhorted them to spend their way out of the recession. The same message was given after the terrorist attacks on New York and Pentagon: Show them the American way of life by shopping! And this also came to pass. Spending has remained far higher than during earlier economic slowdowns.

If interest rates go up, however, there will be a triple whammy. One, the large loans people already have will be more expensive. (This will take some time to take effect on mortgage, which is typically bound for quite a while. It will hit unsecured loans immediately, though.) Two, property values will stop rising and eventually start sliding. Since people have borrowed to the chimney, they will find themselves with loans larger than the value of their property. This is bound to make any sane person nervous. Nervousness is not good for recovery. Third, as is already seen, the dollar will strengthen. This is exactly the opposite of what is needed if the country is ever to pay off its rapidly rising debt to the rest of the world.

Well then, why would anyone ever want to raise interest rates? Higher interest rates encourage saving, and make companies and families think twice before spending too freely. This is good during an economic boom, when people are throwing money at stupid projects. It can be argued that it should have been done much earlier last time, but there were global problems back then which only the USA could solve. America saved the world economy back then, and now it is time for the world to save the American economy. This requires a cheap dollar, and the only way to keep it down is to keep interest rates down. There are still about 2 million jobs left till lack of workforce becomes a serious problem, and I sincerely doubt this will happen anytime soon.

Before the country can get another boom, it needs a stable source of income. During the years from 2001, spending has largely been financed by tax breaks and refinancing mortgages. The refinancing is pretty much in the past already, and tax breaks may continue but they cannot continue to grow. So even if nothing is done to cool down the economy, it will slow down by itself. At best there is hope of moderate growth, and this depends on trade imbalance being fixed in a gentle way, that is to say: An ever cheaper dollar. It also depends on continued globalization and free trade, which have served the US (and the world) well in the past. Kerry, as far as I know, is an enemy of both. (Breakdown of global trade caused the Great Depression. Spot the irony.) And Bush is too simple-minded to see that budgets should be balanced. Poor America. Plague or cholera? Your choice.