EYE ON
AMERICA End of the guns and butter
economy By Scott B MacDonald
NEW YORK - Over the past 30 years, the
United States has sought and to some extent
achieved a guns and butter economy; that is the
pursuit of both political-military objectives and
an affluent lifestyle.
On the political
front, it has dominated the international system,
presiding over the defeat of the Soviet Union, its
hegemonic rival
during the Cold War, and
forming a successful military coalition to
liberate Kuwait in the first Iraq war in 1991. It
became even more unilateral under the Bush the
younger administration, with aggressive policies
against militant Islam and Iraq in Middle East and
South Asia.
At the same time, the
consumer-driven US economy continued to expand,
with the last great burst being the spike in
homeownership in the 2003-2006 period.
Homeownership since the mid-1950s was long stuck
at 65% of the total population, but by year-end
2006, on the back of cheap credit and lax
underwriting standards, it reached 69%.
Significantly, countries such as China,
Japan and Germany benefited from the US guns and
butter economy, content to sell their exports and
finance their purchases via the buying of US debt.
This was the upside of globalization.
But
in July, the US financial system signaled that the
era of cheap money and lax standards was over. Two
Bear Stearns hedge funds collapsed and panic hit
credit markets, pounding the stock and bond values
of any company associated with mortgage lending
and housing. By August the rout filtered into the
derivatives market (especially those structured
financial products that contained exposure to US
subprime debt), negatively impacting European and
Asian bank and insurance investment portfolios.
The contagion eventually rippled into
London's inter-bank market, forcing central banks
to inject considerable amounts of liquidity to
keep the system running. Even then, nervousness
about the standing of banks, especially those
dependent on short-term commercial paper for
mortgage lending, forced Britain's Northern Rock
into a government rescue. This was the downside of
globalization.
The US economy is edging
toward a significant slowdown in what is left of
2007; it will take concerted effort and luck to
avoid a recession. The housing sector is hitting
depths associated with the 1930s. The Federal
Reserve's September 18 cuts in the discount window
and in Fed Funds gave markets a temporary relief,
a situation helped along by private sector actions
to consolidate the financial sector. This is
reflected in Bank of America's purchase of
Countrywide Financial shares and Citigroup's
stepping up with credit lines for GMAC. But there
remains a long distance to the shore of economic
safety.
A shadow is being cast by a
deficit of unresolved problems in an economy
overloaded with debt, a retreating federal
responsibility for national infrastructure, and
large (and seemingly unending) overseas burdens.
In the short term, the problem that looms is that
the housing meltdown is finally chipping away at
the consumer, who in the butter part of the US
economy accounts for about 70% of gross domestic
product.
The consumer relied on home
equity (and foreign capital) to finance the
ongoing parade of goods and drove many households
into negative territory in terms of savings. Why
save when you are penalized (taxed) on savings
amid an unrelenting society-wide pitch to consume?
Easy money during the Alan Greenspan years at the
Fed helped keep the guns and butter economy afloat
without too many major adjustments. That dynamic
has changed.
On the short term side there
is going to be further bad news on housing. There
is a very real prospect of steeper declines in
housing prices, pushed along by a growing
inventory (already nine months of new homes
waiting to be sold not to mention those homes
taken off the market by frustrated would be
sellers).
In addition, there is a huge
resetting of adjustable rate mortgages over the
next 12 months, with a large spike in March 2008.
Adding to the list of woes is the increasing pace
of personnel downsizing in the mortgage industry
and declining profitability in the financial
sector.
On the longer-term side of the
equation, the economic landscape is chilling,
considering the massive structural problems. The
guns part of the economy is a concern - the war in
Iraq and other missions (Afghanistan and Africa)
cost somewhere between US$3-5 billion a day.
In August, the Congressional Budget Office
(CBO) estimated as of June 2007 up to $500 billion
has been spent on combat operations in Iraq. The
CBO also noted that if the United States were to
maintain 75,000 troops in Iraq over the next five
years, the nation would have to pay an additional
$900 billion. Moreover, there are further costs
attached to training police and ground forces in
Iraq and Afghanistan as well as long-term health
costs associated with wounded personnel.
There are other structural problems - a
long-term imbalance between government
expenditures and revenues (related to ongoing
pressure for tax cuts). There is a massive problem
with national infrastructure - it is aging rapidly
and needs to be upgraded with a price tag of $1.6
trillion. That includes roads, bridges, ports and
other public utilities.
Any doubt of the
infrastructure problem one need only point to the
steam conduit that exploded in July in Manhattan -
the piping was laid 83 years ago when Calvin
Coolidge was president and was part of a system
that started to provide energy to New York City in
1882.
In August, a 40-year-old bridge in
Minneapolis collapsed, leaving several dead in the
accident's wake. The national infrastructure is
literally falling down around the population, but
the most recently passed Senate transportation and
housing bill contained at least $2 billion for pet
projects that include a North Dakota peace garden,
a Montana baseball stadium and a Las Vegas history
museum.
Equally important is the issue of
Medicare, Medicaid and Social Security, the
combined basis of which is expected to grow 22%
faster than the economy over the next decade. This
should come more sharply into focus next year when
the first of 78 million baby boomers become
eligible for early social security benefits.
American politics have reached a very
dysfunctional stage, with considerable energy
given to the indulgence of maintaining an economy
and the debt required to keep it going, with
little thought being given to the adjustments now
in motion.
Along these lines, it is easier
to blame the outside world for troubles at home,
hence the turn to protectionism (with a number of
bills pending in the US Congress). The plunging
value of the US dollar and the huge sell-off in US
securities by foreigners in August ($163 billion)
should convey the message that not all is well and
that unless there is an effort to start living
more within one's means, the rest of the world is
going to stop financing the North American credit
glutton.
The days of guns and butter for
the US economy are over; what is going to replace
it is a much more volatile world, with substantial
questions over the US dollar as the major
international currency and the ability of the US
consumer to absorb the world's exports. As the US
adjusts to this changing scenario, so will the
rest of the global economy. It is not going to be
an easy transition.
Scott B
MacDonald is editor of KWR International
Advisor.
(Posted with permission from
KWR International, Inc,
(KWR), a consulting firm specializing in the
delivery of research, communications and advisory
services.)
The views expressed within
do not necessarily reflect those of KWR
International, Inc.
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