A view of the economy.
Note: This was originally published on 1 February 2000.
There may be trouble in the economy. Most pressing are the unsustainably high levels of private debt and the trade deficit. Of lesser threat are public debt and inflation.
Although public debt has remained approximately equal to national income (GDP) for several years now, the trend is downward. Responsible for the end of the era of budget deficits is the burgeoning period of economic growth. Without a significant hike in the tax rate, tax revenues are nevertheless far above their previous level due to increases in wages, salaries, and profits. More governmental revenue and restrained government spending has resulted in the beginning of an era of budget surpluses. GDP grew 4.3% in 1999, including 5.8% over the last three months. Inflation remains largely curbed, with consumer prices rising 2.7% in 1999, and producer prices 3.0%. Unfortunately producer prices rose 4.5% over the last three months, possibly indicating more inflation ahead.
In my view, however, inflation is not a real danger. The unemployment rate remains steady at 4.1%, dropping only slightly from 4.3% last year. This leaves millions of workers looking for work. Controversy arises when right-wingers argue that approximately that many workers are likely transitioning between jobs, and on the other hand left-wingers argue that the unemployment rate undercounts the number of workers actually without jobs. While those on the right-wing argue that more economic growth cannot take place without bidding wars for scarce employees, the economy continues to boom with only slight inflation and a steady, if a slow reduction in unemployment. The only bidding wars going on are in very selective job categories, such as software developers. The unemployment rate undercounts by skipping those who aren’t seeking a job, and the underemployed. The ranks of the underemployed include those part-time workers who would prefer a full-time job, or simply more hours. If the full amount of unemployment were counted, the rate would be 2 or three times higher than it it today. There is quite a bit of slack left to take up in the labor market before inflation sets in.
Inflation might be limited further by surplus inventories. A number of companies, McDonald’s for example, took the Y2k precaution of stocking up on inventories of basic goods and supplies. Since few problems arose at the onset of the new year, such companies will need to draw down their inventories, reducing future purchases until their inventories are again at comfortable levels. It seems likely that the corresponding reduced demand for producer goods will maintain enough supply to stem any further rise in producer prices.
The Federal Reserve Board’s Open Market Committee, presided over by Alan Greenspan, will probably announce a relatively large increase of 0.5% in short-term interest rates to fight the threat of inflation. The greatest effect will be to soothe the inflation fears of investors, however. With inflation nearly stalled, the action does not seem appropriate outside the necessity of fulfilling public expectations.
A far larger problem than public debt is private debt. Private debt as a percentage of GDP has steadily risen, from 80% in 1960 to 132% today. This relatively high level of private debt has accrued due to low interest rates and continual economic growth. Should the economy begin to stall, however, this debt burden would significantly worsen the situation in households with high debt levels, and for employees of companies that can’t pay borrowers back.
A common theme in the news is a bemoaning of easy credit for consumers, and a moralized enjoinder to audience members to not immerse themselves in debt. Nevertheless, total household debt increased from 85% of total household income in 1992 to 103% in 1999. Historically, this is a high level. With low interest rates, consumers are spending more freely with credit cards and taking on more mortgage debt than they can easily pay back. It likely will not remain that high for long without fairly serious consequences.
The truly overbearing problem is not credit cards and mortgages, however, but the relation between stock market prices and the ability of consumers and businesses to service their debt burdens. One of the lessons supposedly drawn from the stock market crash of 1929 was that allowing speculators to borrow in order to increase their leverage in an equity was fraught with risk. Regulators seem to have forgotten the lesson. Over the last two months alone, as the major stock market indices have risen, margin debt has increased by 25%. Should share prices fall by a significant percentage, borrowers on the margin who lost their bets will be called to pay more into the house to keep playing. Should this scenario take place, would they have the money?
Additionally, many corporations are dependent upon a healthy share price to do such things as pay employees bonuses and merge or acquire other companies. For example, many Internet companies pay their employees miserly wages, relatively speaking, but make up the difference in stock options. With the late boom in the IPO market, many talented people have taken such jobs with an eye toward hitting it big when the IPO takes place. Many of these have been successful. Additionally, companies like AOL are able to buy others, like Time-Warner for $166 billion in an all-stock transaction. Non-financial corporations have bought back large chunks of their own shares despite borrowing above and beyond this level. Should a crimp in their cash flow take place, companies may halt their buybacks, further depressing share prices.
The biggest worry for the US economy is the trade deficit, however. Currently the trade deficit, or current account deficit stands at 4% of GDP. Translated, that means that 4% of national income is going to other countries. Another way of looking at it is that foreigners are holding a larger and larger chunk of debt in America. This has in part is a side-effect of the economic boom. With the American economy doing well, inherently and in comparison to others, an investment in American securities is wise. Looked at in still another way, this is another symptom of the US debt burden, both public and private. The American economy is awash in debt, not in investment. The savings rate is not nearly so high as it is in other countries, especially Japan. Thus, there will be less investment by Americans in foreign countries, and less profits coming home as a result of it. America is a victim of its own success. If it weren’t for the tremendous value American investments return to foreign savers, the trade deficit would disappear. But then, other problems would arise.
The recent news is that the euro (€) has fallen below the “psychologically important waterline of $ 1 / € 1. The European economies remain as a whole sluggish. The German economy in particular is an underachiever, with double-digit unemployment accompanying a meager 1.2% growth in GDP in 1999. The slow-growth situation in Europe has led investors to shun the euro, despite its heralded role of challenger to the dollar. Before we Americans start cheering, however, we’d best consider ways to weaken the dollar. The result would be more exports and a lowering of the trade deficit. The trouble with the trade deficit is that it makes debt harder to service. Foreign investors want what’s coming to them. If the American economy can’t generate enough export income to pay the piper, they will gladly take their part of national income. And should the economy tank, the low domestic savings rate will mean a continued American reliance on foreign investment. The only way to continue to entice it would be to raise interest rates. That’s just what you want to avoid when your economic cycle goes bust.
Let me strongly suggest that I am not a doomsayer. I am simply encouraging the private sector to follow the lead of the public sector and balance their budgets. I’m also suggesting that we attempt to increase exports wherever possible. It is a controversial political stance, but it is also a reality. The US is trading with China. President Clinton said it best in the State of the Union address. Our markets are already open to Chinese producers. The trouble is that their markets are not open to US producers. China already has one of the world’s largest economies. China is an extremely lucrative export market. One projection even shows that they will be a net importer of food within a few years. Opening more trade with China will enrich both countries. As for the moral qualms, I don’t see how trading with them will do any harm at this point. The Chinese are rapidly transforming their economy into the capitalist mode of production. It’s unlikely, in my view, that a rush of American goods will threaten that. The larger political question is if free trade doesn’t naturally bring about democracy (and no evidence indicates it ever does), do we wish to trade with them or isolate them. I say trade with them now or have to deal with them on a less peaceful basis in the future. Whatever that might be, peace and trade are vastly preferable.
Credit where it is due. Much of my figures and analysis come from the Economist, 22 January 2000. I recommend the Economist as a magazine worth reading. One probably needs to read between the lines, or simply be aware, however, to catch their political slant on things, well-justified or not. On the whole, though, it’s an excellent publication in an era where typos, quizzes, glossy photos, and bright color contrasts fill the popular news journals.