Economic outlook 2001.
Note: Originally published 19 March 2001. Updated 25 March 2001. Thanks to pen-l subscribers for critical commentary. Updated 12 December 2003 to remove the political commentary that appeared at the end.
When the US economy grew with less vigor in the fourth quarter of 2000, could Europe be starting to flex its muscles? Now, with the central bank of the US set to lower interest rates, a steady rise of the Euro against the dollar is possible. A fear of a fall off in the value of the dollar; a reduced US government surplus or potentially even a deficit; and a reduction in interest rates paid to lenders; all reduce the incentive to invest in the US economy. The overall economic outlook for the United States is thus poor.
U. S Gross Domestic Product increased 4.2% in 1999. In the four quarters of 2000, US real GDP increased at annual rates of 4.8% (1Q); 5.6% (2Q); 2.2% (3Q); and 1.1% (4Q). Growth slackened as the year progressed. Overall, real GDP grew 5.0% in 2000. BEA. The fourth quarter numbers are preliminary estimates.
The accumulated national debt now stands at $5.7 trillion. Treasury. Japanese investors alone hold about $350 billion in US treasuries, and $150 billion in other direct investment in the US (FDI). NYT. (Thanks to L. P. for the link.)
Lower expected returns would prompt some of these investors to liquidate and re-invest elsewhere, quite likely in other countries. Far beyond the fraction of US economic space these investments occupy, the effect of a sell-off would be felt in the US in the downward trend of the value of similar investments. For this reason and reasons analogous to it, the US central bank authority, the Federal Reserve’s Open Market Committee, does not have the room to maneuver that a monetarist response would require. If “the Fed,” as it is affectionately called, lowers interest rates too much, the value of the dollar will decline in relation to the euro and other world currencies. Japanese and other investors would have an incentive to take their money out of the US and put it into other countries. Thus, it is unlikely that they can budge interest rates down much more than they have already done. The Open Market Committee’s next move is set for tomorrow, March 20.
If a monetary policy won’t work, will a fiscal policy cut it? The Bush tax cut, a fiscal stimulus plan, is unlikely to have much effect because it will go in large measure to those taxpayers who already have relatively high incomes, and thus relatively high discretionary incomes. They will be free to invest the money rather than spend it. They will also use some of it to buy imports that will not help economic growth immediately. Investments can result in economic growth eventually, but only with time. Taxpayers with lower incomes and lower discretionary incomes would spend the money they receive much faster, resulting in a boost to consumption spending, and directly translating to an increase in GDP. If any tax reduction package is passed, it will have to be weighted heavily in the favor of the rich to win the President’s signature, however.
The US economy will clearly grow slowly in the first quarter of 2001, or actually decline. Reduced income tax receipts will follow, resulting in a lower budget surplus, or possibly a deficit. In a similar vein, some states are already reporting dramatically lower sales tax receipts. NPR, 19 March 2001.
Another impediment to a positive effect from tax cuts would be the need to phase in the cuts over time. Without front loading, no impact at all would be felt until 2002. President Bush advocates front loading (changing the withholding rates after the legislation is signed into law), but even then the plan’s largest impact will take place years from now, especially of that part of Bush’s tax plan which abolishes the so-called “death tax,” or estate tax, which applies only to the estates of dead people with a net worth greater than $675,000.
Reduced profit prospects in the US should steer capital to the other major capitalist economies: Japan and Europe. Japan, however, is in the midst of a long recession. If money was pouring out of the US, much of it should be going to Europe. The new European Union currency, the euro, should naturally benefit from this.
The euro is not going anywhere, however. One euro (€) is currently worth
0.897845 US dollar. See a web site for an up-to-date conversion. This represents a three-month low spot for the euro. Euro-zone consumer prices rose an unexpectedly high 2.6% annual rate in February 2001, uncomfortably high above the European Central Bank’s target of 2%. FT. The UK pound was not significantly better off against the US dollar than the euro over this period. Useful Java based graphs are available at The Economist. The €/$ ratio may increase, however, if American fortunes continue to decline, and European fortunes improve. If US interest rates decrease, the value of the dollar may decline in relation to the euro, and that could staunch the outflow of capital in the current account deficit, but it will not really help the situation, because the import-dependent American economy would have to spend more to buy badly needed imported goods and services.
The American outlook is particularly grim due to the export and import picture. The current account deficit (commonly known as the “trade deficit”) of the US grew spectacularly from $331.5 billion in 1999 to $435.4 billion in
2000. BEA. That much money flowed out of the US last year. Increases in the price of petroleum exports accounted for much of this.
It doesn’t help that OPEC nations are determined to raise the price of oil in order to protect their profits from the expected fall off in demand for their product. Yahoo. The reduction in world oil demand is a result of failing economic fortunes in Asia and the United States. The Bush tax cut plan would only exacerbate the current account deficit, albeit in non-spectacular manner, from the increased number of luxury imported goods that tax cut beneficiaries would buy. If only the European economies would now begin to take up the slack left by the American economy’s sluggishness, the world economy would continue to prosper. It does not look like Europe has the capability to be the world’s economic leader, however.
The economies of China and India, or even Russia, can draw upon natural resources and large populations, but none appear ready to grow as the then-lionized newly industrialized countries did in the 80s and 90s. Each of the three is too mired in corruption to attract much Western capital. Efforts at combating corruption are underway in both Russia and India, however.
Is OPEC to blame? The increases in 1999 and 2000 of fossil fuel prices has surely hurt the US economy, but not to the extent done by the 1970s oil price inflation.