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The IMF and the US
economy
By
John Berthelsen
The International Monetary Fund
(IMF), famous for flensing the skin off developing
nations for sins of economic excess, has issued a
101-page report on the American economy and some of its
most precarious features - particularly its budget
deficit and the state of its housing market. The picture
is mixed, with some comfort for the Bush administration
and some ammunition for its critics.
The report
is extremely cautious as befits its putative role as the
United States' global economic policeman. It points out
on its front page that in keeping with the publication
of all staff reports, the policy of publication "allows
for the deletion of all market-sensitive information".
There is thus nothing in the report that would
argue against the current rising stock market or the
dollar's recovery against the euro. However, although
the IMF carefully stays away from drawing conclusions,
the sum and substance is that major components of
macroeconomic growth could break down, and if they do,
with production capacity idle and unemployment high, the
bounce that stockbrokers are anticipating might not
materialize.
There is no housing bubble, but
prices are high, particularly on the west coast and in
New England, and they could drop precipitously if
interest rates rise; the Bush administration's obeisance
to supply-side economics is unhealthy; consumer saving
is only a percentage point below trend, but there is
potential for problems; defined-benefit pension plans
are a small part of total retirement, but they are
seriously underfunded; the administration's energy
policy is spendthrift and contributing unnecessarily to
global warming. (Globalization and the conversion of
world business cycles, treated in the report, will be
the subject of a subsequent Asia Times Online analysis.)
In particular, the report, prepared by a team of
11 economists, gives short shrift to the effectiveness
of so-called supply-side economics, advanced by the
economist Arthur Laffer, that deep tax cuts free enough
up enough capital to generate economic activity. The
Laffer curve, as it is called, didn't work for Ronald
Reagan when he was president and it is not working for
the George W Bush administration, which now faces a
skyrocketing budget deficit is officially put at US$450
billion and unofficially at as much as $650 billion.
Instead, the economists write, the short-term
stimulus of such tax cuts is minimal and temporary, and
that "budget deficits have adverse effects in the long
run, both domestically and abroad". Higher levels of
public debt generated by tax cuts can be expected to
drive up global interest rates from what is known as
"crowding out", as the borrowing needs of the US
government overwhelm the amount of money available in
global markets.
Higher global interest rates are
a serious concern for the Asian economies, most of which
are hostage to the American import market. Also, if
American consumers were to stop their buying, the Asian
economies supplying them with consumer goods would be in
serious trouble with cascading problems all down the
line. Despite attempts to wean their own economies off
exports to become consumer-driven, many Asian economies
are more dependent on exports than ever. The US imported
$121.4 billion in goods from Japan in 2002, $125.2
billion from China, $33.6 billion from South Korea,
$32.2 billion from Taiwan and $9.6 billion from Hong
Kong.
After the budget deficit, probably the
most pressing of these questions concerns the
possibility that a US housing bubble, if there is one,
might pop with an explosion equal to the one that
collapsed world equity prices. As US Federal Reserve
Chairman Alan Greenspan ordered a series of rate cuts
that drove interest rates to their lowest levels since
World War II, millions of homeowners, motivated by
rising house prices and plummeting interest rates,
refinanced their homes, took the money out and have been
spending it on consumer goods. Millions of others took
advantage of the low interest rates to buy new or
existing homes, fueling the need for everything from
durable goods to new cars. This explosion in consumer
spending propped up the American economy through three
years of economic decline.
Greenspan has
repeatedly testified that he finds no evidence of a
bubble. The IMF team, studying some 250 metropolitan
statistical areas, agrees, saying that "price levels in
most areas are broadly consistent with increases in
personal income". The study does find, however, that 20
of the 250, including the largest metropolitan regions
in the US, "were identified as being excessively
priced".
"Deteriorating employment conditions in
some of these markets [eg, around California's Silicon
Valley] have had a limited impact on housing price
inflation." In the American Midwest and south, the
report says, "prices are mostly in line with underlying
variables, while in the West and Northeast, prices are
above model predictions". Thus the odds of a major
meltdown of the US housing market are probably remote.
A report for Congress written by the
Congressional Research Bureau of the US Library of
Congress makes much the same point, saying that while
there were major increases in house prices in California
and New England, rises n prices in the rest of the
country has been largely in line with inflation. That
means that while the California market could melt down,
as it did in the early 1990s, and take New England with
it, the rest of the country is liable to remain stable.
If interest rates were to rise sharply, a concern of the
bond market, house prices would probably drop, but if
history is any guide, they would probably come off by a
magnitude of about 20 percent, the research bureau
suggests.
The next most immediate question is
whether the bank balance of the profligate American
consumer, whose average savings rate actually went
negative in the late 1990s, poses a risk to the economy.
Here the evidence is mixed. The IMF team found that
household net worth had fallen sharply since 2000, from
about 6-1/2 times personal disposable income to about 4
times, partly as the air went out of the 1990s equities
balloon. Consumers have shifted savings from equities
into cash, driving up personal savings
slightly.
From 1969 to 1996, equity holdings accounted
traditionally for about 20 percent of household wealth,
but then zoomed up sharply, to about 45 percent before
falling precipitously back to 25 percent again. While
there were major concerns that American average savings
had fallen to the lowest point in history, they have
started to recover as savers switched out of equities to
savings. However, savings remain about a percentage
point below the historically low American average.
And, "despite the moderate shortfall in personal
saving relative to levels determined by savings and
wealth, any upward adjustment could weigh on the
short-term outlook." In other words, if consumers give
up their profligate ways and save, the economy could
cool off even from its current lackluster rate.
Furthermore, the researchers said, "a larger correction
in the savings rate remains a risk of the economic
recovery disappoints".
The funding shortfall in
defined-benefit pension plans is a cause for bigger
worry. While the numbers of participants in these plans,
which are concentrated in manufacturing and heavily
unionized industries, are diminishing, underfunded
obligations are already cutting into corporate profits
and credit ratings.
Underfunded pension
obligations have already acted as a drag on corporate
profits and credit ratings for a number of major US
corporations. The recent failure of a number of large
companies with significantly underfunded plans has
already weakened the finances of the Pension Benefit
Guarantee Corporation, the federal agency that insures
private pensions, the researchers found.
Adverse
demographic trends are starting to bite - the number of
retiree participants in the plans will outnumber the
contributors for the first time this year. Thus, with
more people retired and living on the plans than are
contributing to them, employers will have to meet
funding shortfalls by increased contributions, which
will cut into profits. "Pension costs have already
dampened profit growth in 2002, with firms in the
S&P 500 tripling their pension contributions over
the previous year, to $46 billion," the researchers
found.
A strong economic recovery, the
researchers write, "could help strengthen the position
of defined-benefit plans and ease the burden on
profits". However, there are few economists who foresee
a strong US recovery very soon. Financial problems, they
say, do not appear to have been wholly due to excessive
investment in equities before the stock market bubble
collapsed. Other problems stem from underfunding the
pension plans in the first place in the face of
long-standing demographic problems that would inevitably
result in a decline in the number of workers, and
declining bond yields.
Other chapters deal with
the impact of energy price shocks on the US economy and
whether taxes should be increased on energy use. The
report is critical of the Bush administration's National
Energy Policy in 2001, saying that "none of the
initiatives [put forth by the administration] have laid
an emphasis on taxes as a means of discouraging energy
consumption".
The focus has instead been on
measures geared towards boosting domestic supply and
developing new technologies to increase the efficiency
of energy use. Reiterating the obvious, the report
states that higher US energy intensity has been
associated with higher levels of emissions of
pollutants, particularly greenhouse gases
Taxes,
the report points out, can play an important role in
achieving conservation and environmental goals. The Bush
administration, however, has shown no sign whatsoever
that it would consider such an idea and in fact is
absolutely antithetical to the idea of taxation of
energy.
(Copyright 2003 Asia Times Online Ltd.
All rights reserved. Please contact content@atimes.com for information
on our sales and syndication policies.)
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