By Clare W. Zempel
Massive monetary and fiscal stimulus has worked. A self-sustaining economic expansion is now in place. Consumer spending and housing remain firm. Businesses have at last shifted from defense to offense. And the Federal Reserve’s determination to keep interest rates low means that more upside economic surprises are ahead.
The “post-bubble babble” that pandered to our worst fears has faded. That babble had based its extreme pessimism on superficial comparisons between the 1929 crash and the collapse in NASDAQ stocks in 2000. Extended economic depression followed the 1929 crash. A similar fate was sure to follow the 2000 collapse. Or so we were to believe.
Good evidence has now driven out such bad forecasts. The uncertainties associated with terrorism, scandals and war declined in 2003. This allowed the fundamentals to reassert themselves in earnest. Tax cuts and low interest rates supported further advances in consumer spending and housing. Corporate profits recovered and business investment followed on schedule.
With all major economic sectors now in an upturn, and with more stimulus in the pipeline, we are far less vulnerable to whatever new shocks occur. Major economic downturns do not occur without abrupt increases in interest rates or taxes. Interest rates could well rise but a steep increase seems improbable. The same applies to a tax hike. Recession risk is nil and should remain low.
Good economic evidence has shifted consensus expectations toward optimism but doubts still exist. The doubts seem centered on weak job creation. The odds are that the popular payroll survey on jobs understates the improvements in the labor market since March. The lesser-known household survey, which tends to be more sensitive to economic shifts, shows a much more substantial improvement. The historical record shows that job creation should not have turned robust until just about now.
Dollar weakness and the trade deficit have become major new concerns. The basic reason that we run a trade deficit is that we invest more than we save, forcing us to borrow from abroad. We could save more but a major decline in our dependence on foreign finance would require a sharp reduction in investment. But less investment would undercut future economic expansion and reduce future living standards. And who wants that?
It somehow seems natural to think that a nation with a healthy economy that provides more jobs and rising incomes for its citizens will have a trade surplus with other countries. It somehow follows that a nation with a trade deficit does not have a sound economy. Natural or not, experience contradicts this view over time and around the world.
Consider our own historical record. In 1790-1875, our merchandise trade balance was in deficit almost all the time but our output rose tremendously over that period. Since World War II, our trade balance has “improved” – that is, the surplus rose or the deficit declined – when our economic performance was weak. Above-trend economic performance was associated with deterioration in our trade balance. The last time our trade deficit was in surplus was 1975, but our economic output and employment levels have soared since then.
The dollar’s decline reflects a reduction in economic risk abroad and not a decline in conditions and prospects here. This reduction in risk reflects the broad worldwide economic upturn that developed sustainable momentum in 2003. It also reflects positive shifts in policies in Germany, France and elsewhere – shifts that improved their economic prospects relative to ours. The dollar’s decline also unwinds the “safe haven” premium priced in when the outlook abroad was at its worst.
Is the dollar vulnerable to a further “massive” sell-off? Not unless U.S. policies shift sharply in an anti-growth direction (for example, by sharply raising tax rates and regulatory burdens, imposing tariffs and quotas on imports, and/or raising interest rates steeply) or in a pro-inflation direction (by rapidly expanding the money supply). Neither shift seems at all probable now that economic expansion has started to create jobs. Absent a major anti-growth policy shift, a further dollar sell-off would just make U.S. assets much more attractive relative to foreign assets. Such a sell-off would soon become self-limiting.
Prospects abroad may have improved relative to ours, but that does not mean that our own prospects have diminished. Business investment turned up here soon after corporate profits rebounded. This means that opportunities to earn substantial returns on new investment remain abundant here.
From a top-down perspective, the dollar’s decline and the broad worldwide economic upturn should raise our exports and reduce our imports. This should reinforce our economic expansion in Real GDP terms and lead to more domestic job creation. From a bottom-up perspective, companies that concentrate in products traded in international markets should benefit more than those that do not in the sustained upturn ahead.
Other concerns exist. Worries about the federal budget deficit have been on the rise, but the deficit itself seems to be falling much faster expected. The same applies to deficits at the state and local levels. The stock market looks overvalued and vulnerable to some, but seems cheap relative to low interest rates.
All is not well with the world but it never is. More seems well than the consensus allows. On balance, optimism should outperform pessimism in 2004.
–Zempel is an economics and investment strategist in Fox Point. Reach him at [email protected]