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Now Battle for the Economy

After Iraq, it was all going to become clear. Tensions over the approaching war distorted the US economy so much that it was impossible to tell whether it was moving into recovery or relapse.

So now that the war is past, which is it?

First, a word on the story of the Great American Bust so far.

The problem for the US was that American companies had stopped investing. Most US recessions begin when the consumer stops spending. This one was different.

In 2000, corporate America realised it had been in a frenzy of investment, had too much capacity, and abruptly stopped.

So the authorities' strategy for restoring the economy was simple. Keep consumers spending until companies recovered to the point where they would start investing again. The support the authorities supplied to keep consumers spending was, and remains, stunning.

Alan Greenspan's Federal Reserve cut official interest rates so far that they went from being positive by about 4 per cent to become negative by 1 per cent or more, after adjusting for inflation. And they've been at that super-low level for six months now.

And the Bush administration persuaded Congress to spend so much money that together they turned a $US200 billion prospective surplus into a $US300 billion-plus deficit. That reversal of half a trillion dollars, or 5 per cent of the country's gross domestic product, was one of the biggest and swiftest fiscal switches in postwar US history.

Together, these two policy legs - monetary and fiscal - offered extraordinary levels of support to keep Americans shopping until corporate America was ready to start investing again.

Early this year, the authorities confidently predicted that this would all fall into place by now. Last year the US economy grew by 2.4 per cent.

But the new US Treasury Secretary, John Snow, said in early March that in April "we'll immediately begin to see a big bounce in the economy", which would recover to 3.5 or 4 per cent growth this year.

The seers at the Economic Cycle Research Institute in New York agreed that April would be crucial, but not necessarily as happy as Snow wanted people to believe.

The institute, which specialises in monitoring a broad array of leading indicators to divine the economic future, found the economy at a "tipping point", where it was vulnerable to tipping back into recession.

Then the US launched the war.

Now that the war is past, where are we?

The Economic Cycle Research Institute reports the good news: the US economy has moved beyond the tipping point and is now heading into an expansion, says its managing director, Lakshman Achuthan.

But it also has not-so-good news. It looks like the same sort of expansion the US experienced last year. "We had a sub-par recovery last year and we are returning to the same sub-par recovery path this year," the institute says.

That's not exactly dreadful. Another year of growth in the 2 to 3 per cent range would be reasonable by the measure of history. For 30 years, the US has averaged growth of some 3 per cent.

But it is very bad news for the jobs market. Unemployment has been worsening and now stands at 6 per cent. The US needs economic growth of 3.5 per cent as a minimum to make any inroads into the ranks of the unemployed.

This is not just a problem for the out-of-work. If the ranks of the unemployed swell too much, it saps consumer spending. The jobless don't exactly binge on new cars and home appliances.

And it is also a problem for the President. Postwar US history shows that, to win re-election, a president must have restored the economy to the previous peak of its prosperity. For George W. Bush, this means he has to recreate the prosperity of 2000, the climax of a go-go decade of stock mania and record growth.

But wait.

The Treasury's John Snow and a number of market economists are saying that it's too early to draw conclusions about the upturn. Why?

Because the President's tax package is still being negotiated through Congress and companies are withholding their investment decisions until the country knows the size and shape of the new tax measures.

Bush asked Congress to pass a 10-year $US726 billion ($1.14 trillion) package of tax cuts. Macro-economic Advisers of St Louis estimates that this would add 1 percentage point to the pace of economic growth in the first year.

The Senate has agreed to only half this much, which Macro-economic Advisers says will halve the stimulatory punch of the package. The House of Representatives wants something in between - $US550 billion in new tax cuts. The final outcome will not be clear for some weeks.

But when it is, Brian Wesbury of the Chicago investment bank Griffin, Kubik, Stephens & Thompson, says that the US economy is "a loaded spring". Companies will then begin the long-awaited investment boom that will then trigger a rapid burst of 5 per cent annualised growth, renewing the cycle of sustainable growth.

But what do the companies themselves think?

Unfortunately, the president of the Manufacturers' Alliance-MAPI, an association of some 400 firms, Tom Duesterberg, finds that theory implausible: "So the war was creating the uncertainty that sopped corporate investment, but now that the war's over it's the tax package? I don't think so. It's not a significant issue for companies.

"Companies are very wary at the moment. What they need to see is several months of strong demand and strong economic conditions before they start investing again."

The Economic Cycle Research Institute's Achuthan says that companies have three prerequisites to start investing. He calls them the three Cs: cash, confidence and capacity restraints.

Corporate America is starting to accumulate more cash, but it has little confidence - and in most sectors firms still have too much capacity, rather than any shortage.

The missing ingredient in America's upturn - the corporate investment that has been absent for three years now - remains elusive.

And the Federal Reserve's first post-Iraq assessment of the US economy concurs that conditions remain dangerously weak. The Federal Open Market Committee, this week said that deflation - persistent falling prices, the opposite of inflation - was the big risk.

The FOMC has been in existence since 1935 and Fed historian Allan Meltzer has read every announcement that it has issued. "This is the first time it's put deflation at the top of its agenda," he says.

Deflation has a bad name thanks to the Great Depression. It's not necessarily disastrous provided it is mild. But the Fed's warning is a harsh reminder that US stockmarket investors lost $US7 trillion in the last three years and this weighs heavily on the US no matter how much policy support the economy gets.

So, after Iraq, the evidence so far for the superpower's economy: neither renewed boom nor bust, but an uneasy and uncertain middle course.