16 May 2003 The Best Growth Environment in World History?
It has been easy to focus on the numerous hurdles our economy has endured over the past several years and to assume that new ones will continue to manifest themselves, keeping us in the doldrums. But, what if things started going right, or even mostly right, for the next several years? One might argue that conditions have never been better in history for growth than they are today.
Trade flourishes during times of peace. As a result of the successful war withIraqand the war on terror, those who would threaten the peace have witnessed the consequences and are likely less bold and organized than they were a few months ago. It is possible that the ‘roadmap’ to peace betweenIsraeland the Arabs will succeed as an independentPalestineis created. President Bush andSouth Korea’s new president, Roh Moo Hyun, emerged from their first meeting declaring that the two countries “will not tolerate nuclear weapons inNorth Korea.” It’s too early to tell how that crisis will end, but hopefully Kim Jong Il’s threats will prove to be no more than bluffs to achieve his objectives of aid.
The consumer is well aware of today’s low interest rates. He has refinanced his home (several times for some) and has purchased new cars with zero percent financing. The Fed is intent on keeping rates low until this economy returns to a more normal growth pattern. The recent talk of deflation has brought the thirty year treasury to an all time low of 4.45%. The chart below shows the steady, but dramatic decline of the 30-year’s yield over the last twenty years.
As the yields on longer term bonds fall, banks are forced to find other investments yielding larger returns, like loans to corporations. Previously they could make a very good return on risk-free treasuries and were less inclined to take the risks associated with lending to corporations, no matter how creditworthy.
Indeed our corporate propensity to take risk seems to be in remission at present, but not indefinitely. In a speech yesterday, Stephen Friedman, the President’s chief economic advisor quoted John Maynard Keynes’ famous remarks on animal spirits. A more complete example of the text appears below:
“Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits – a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.”
“… human decisions affecting the future, whether personal or political or economic, cannot depend on strict mathematical expectation, since the basis for making such calculations does not exist … it is our innate urge to activity that makes the wheel go around …”
Friedman pointed out that theU.S.is in a better position thanEuropeorAsiato lead the world out of its current malaise. He highlighted factors such as our ability to react to changing fundamentals at the government and the corporate levels. He added that the U.S. Fed maintains a very accommodative fiscal policy, unlikeEuropeorJapan. Finally, our fiscal policy is working, according to Friedman. Tax cuts in 2001 led to one million new jobs and the cuts in 2002 have created an additional 200,000 new jobs.
Our banking system remains solid after some very challenging times. Capital markets are behaving well now, and the spreads between corporate bonds and risk-free treasuries are coming down, a good sign that businesses are beginning to get the funding they need. When the economy does gather momentum, our financial institutions are in excellent position to benefit both themselves and the markets they serve.
The key driver to the strength of theU.S.economy over the past decade has been the productivity miracle. Through technology, fewer and fewer workers have been able to produce more and more goods. It has been a boon for workers as the preponderance of economic benefit flows to them in the form of higher wages and better benefits. The owners and providers of capital have benefited as well through better profits, but not to the extent of the American worker. This fact helps explain why the consumer has been able to maintain relatively high levels of spending through this slowdown.
But there is a paradoxical downside to productivity. As fewer workers produce more goods, the need to hire additional workers depends on growth in the sale of those goods. If the economy’s demand for finished goods and services does not increase fast enough, demand for additional workers declines as rising productivity continues to displace them. We are in such a quandary now.
The Administration and Congress are currently wrangling over the best form of tax legislation to stimulate job creation. The talk of deficits is mostly political as the traditional positions of Democrats and Republicans are reversed. Republicans, by in large, believe that it is the governments’ responsibility to turn on the money faucets during war time and during economic slowdowns (and to keep their man in office), but they traditionally are the champions of sound budgetary policy (in rhetoric if not action). Democrats (normally the more free-spending of the two parties), on the other hand, are decrying the budget deficits that may result from the tax cut measures proposed by the President and most Republicans. They stand to benefit in the next elections if the economy falters. Greenspan weighs in by saying that the tax cuts are not advised, because the Congress has rarely proven it can maintain the spending constraints necessary to avoid ballooning deficits. Nevertheless, some meaningful tax legislation is expected by this summer and it should act as further stimulus on the economy.
And what’s all this worry about the declining dollar? Obviously there is the risk that the dollar might continue its decline, throwing the world’s financial systems into a panic. A long term look at the dollar reveals that it is simply returning to its historical levels. The U.S. economy remains the leader of the world economy and to invest in it, requires dollars.
In short, a cheaper dollar is very good for American businesses who export much of their production. When an American computer or a car is offered for sale inEurope, or any non-US region, the price of that product is affected somewhat by the relative value of the currencies. Since February of last year, the dollar has fallen relative to the Euro from 120.51 to a new low of 94.18. That means the American car or computer offered for sale inEurope(in euros) has fallen in price by almost 22% relative to similar European computers or cars.
Indeed this past quarter, many American corporations stated that favorable currency translation was a major part of their profitability for the first quarter. European companies, on the other hand, are blaming the same thing for their ailing sales. Until the European banks become more growth oriented and less inflation fearing and reduce rates, which would help bring the two currencies into a more normal parity, the conditions will not improve forEurope. It is clear that our Fed is not going to raise rates any time soon. It is more likely that they will lower them once again, very soon. One reason is that the twelve month LIBOR is and has been for some time now, below the one-month LIBOR. The short term yield curve is inverted which indicates future policy change.
Economic releases this week continued to be mixed, but the positives seemed to outshine the negatives, both in the market’s reaction and in degree. Those negative indicators seemed to show a decelerating decline, while those improving measures took larger jumps.
The Empire Manufacturing Index surprised significantly to the upside indicating that conditions forNew York’s manufacturers improved substantially in May. Expectations for conditions six months ahead rose for the second straight month and many of the future indexes returned to levels not seen since pre-war January.
The University of Michigan’s Sentiment Index rose to 93.2, the highest in a year as the fighting inIraqwinds down. The index has surged 15 points since March when it slumped to the lowest level in a decade. Bloomberg points out that a sustained rise in sentiment may help spur consumer spending and boost the economy after the weakest six months of growth since the recession ended in 2001.
Many of today’s conditions, while the result of tough times, point to far better times. Taken together, it is difficult to find a time in history where more favorable conditions existed for sustainable healthy economic growth. I’m not an economist, but like Will Rogers said “I have as much right to guess about the future as an economist does.” My guess is based on the economic minutia we discuss each week as well as the views of many analysts and economists. But the biggest part of my guess is based on Keynes’ ‘animal spirits’ and in particular,America’s ‘animal spirits.’ This economy will not be caged much longer. The stock market, up 18% from its low in March, agrees.