roach on the us economy

  1. 374 Posts.
    The piece below by Morgan Stanley's Stephen Roach (New York)

    Washington is coming to the rescue of a deflation-prone US economy. Or at
    least it is attempting to do so. The Federal Reserve has led the way, and
    now the fiscal authorities are joining in. While Republicans and Democrats
    differ on tactics, they agree on the general dosage of fiscal stimulus over
    the next year -- about $100 billion, or 1% of gross domestic product. I
    applaud this rare bipartisan consensus.

    Yet, if anything, a short-term stimulus of this magnitude might actually be
    too little. That's because the United States is close to the brink of
    outright deflation. For the economy as a whole, GDP-based inflation slowed
    to just +0.8% in 3Q02, the lowest rate in nearly half a century. Another
    year of subpar economic growth in the 2% vicinity -- pretty much my personal
    prognosis -- could well find inflation moving even lower, possibly flirting
    with the "zero" threshold of outright deflation. The authorities must do
    everything in their power to avoid such an outcome.

    And so Washington has sprung into action. The Federal Reserve has taken the
    federal funds rate down by an astonishing 525 basis points since early 2001.
    At 1.25%, this benchmark policy interest rate stands at its lowest level in
    over 41 years. The Congress and the Bush Administration are now following
    suit. America certainly needs that. The textbook response to the threat of
    deflation suggests that all forms of stabilization policy -- fiscal as well
    as monetary -- be aggressive in attempting to boost aggregate demand. At
    exceedingly low rates of inflation, the risk-reward calculus urges policy
    makers to err on the side of excessive stimulus. Such "over-stimulus" can
    always be corrected -- if and when the economy is on the mend and
    deflationary perils ebb.

    But the US economy also faces profound longer-term challenges. At the top of
    that list is a seemingly chronic shortage of saving -- the driver of capital
    formation and the sustenance of any economy's longer-term growth potential.
    America's so-called net national saving rate -- the sum of personal,
    business, and government saving after depreciation is deducted -- plunged to
    a record low of 1.6% of GDP in 3Q02. Not only is that less than one-third
    the subpar 6% average of the 1990s but it is only about one-sixth the 10%
    norm of the 1960s and 1970s. This is the domestically generated saving that
    is left over to fund the expansion of America's capital stock. And now
    there's less of it available for that purpose than ever before.

    Moreover, ever-widening Federal budget deficits run the risk of a further
    plunge in national saving. That trend was already evident long before the
    latest fiscal stimulus proposals. In the first quarter of 2000, the budget
    was actually in surplus to the tune of 2.3% of GDP and the net national
    saving rate stood at 6.4%. By the third quarter of 2002, the Federal budget
    had swung into a 1.8% deficit, and the national saving rate plunged to 1.6%.
    The deterioration in the government's fiscal balance accounted for fully 85%
    of the depletion in overall national saving since early 2000. Needless to
    say, without compensating upward adjustments in private-sector saving -- the
    opposite of what today's consumption-oriented policy makers are seeking -- a
    steady stream of budget deficits could well push the already depleted
    national saving rate even lower.

    That would be a most unfortunate turn of events. To the extent that
    America's growth imperatives cannot be financed by domestic saving, foreign
    investors must provide alternative funding. The US can get that capital only
    by purchasing goods from overseas, the root cause of its massive trade
    deficits. Yet in the end, this is a fool's game. America is currently
    running a record balance of payments deficit amounting to 5% of its GDP.
    Rising budget deficits that lead to a further reduction of national saving
    will take the external financing gap up to at least 6%, requiring the US to
    attract about $2.5 billion of foreign capital each and every business day in

    That's a most precarious foundation for the world's growth engine.
    Ever-widening Federal budget deficits not only put a strain on the ability
    of the United States to finance its growth-enhancing investment in plant and
    equipment, but they also leave America increasingly dependent on foreign
    lenders to close the financing gap. Currently, overseas investors own more
    than 18% of the total market value of long-term US securities and fully 42%
    of outstanding Treasuries -- dramatic increases from the shares of
    mid-1990s. Such financing arrangements are tenuous at best. There's no
    guarantee that foreign investors won't demand a price concession on
    dollar-denominated assets to keep the inflows going. As a consequence, a
    saving-short US simply may not be able to afford another era of fiscal
    profligacy without suffering the consequences of a sharply weaker dollar
    and/or a marked correction in other asset prices. Longer-term fiscal
    stimulus plans -- such as the one proposed by the Bush Administration --
    need to be mindful of this critically complicating factor.

    At the same time, tax reform proposals -- however laudable -- need to be
    judged against the yardstick of national saving objectives. That's not to
    say that America doesn't need tax reform. The elimination of the double
    taxation on dividends is one such reform that is long overdue. Such relief
    has, in fact, long been at the top of my reform wish-list -- especially the
    strain that would direct relief at the corporate sector. But that begs the
    more basic question as to whether a saving-short nation can afford a reform
    that entails a 10-year revenue loss estimated by the Bush Administration to
    be in excess of $360 billion. Moreover, the wisdom of using dividend tax
    cuts as a vehicle to provide short-term stimulus can be drawn into serious
    question. There are certainly other less circuitous options -- such as the
    payroll tax reductions the Democrats eschew -- that put more high-octane
    fuel directly in the hands of consumers.

    Perhaps the most troubling aspect of the "Washington fix" is the temptation
    to go back to the same recipe that got America in trouble in the first place
    -- hyping the stock market and the bubble-induced excesses it prompted in
    the real economy. Both the Fed and the fiscal authorities seem more than
    willing to embrace stock-market targeting as a means to jump-start a sagging
    US economy. Fed officials have been quite explicit about the need to spark a
    revival in sentiment that could well lead to another rally in the equity
    market. The Bush Administration has been equally adamant over using dividend
    tax relief as a means to push up share prices, spur wealth creation, and
    boost the consumption of wealth-dependent investors. And the Democrats' plan
    urges stimulus to business capital spending -- the last thing that a
    deflation-prone economy awash in excess capacity needs. Sadly, this is a
    movie we've all been to before.

    America's policy challenge is daunting, to say the least. But in the end,
    the authorities must not lose sight of what stirred them into action -- the
    perils of deflation. For that reason alone, America needs a sizable
    short-term stimulus. But a saving-short US economy cannot afford the luxury
    of multi-year tax cuts and outsize revenue losses associated with long
    overdue and well-intended reforms. Moreover, Washington must heed the
    lessons of the Roaring Nineties and avoid the bubble-induced pitfalls of
    stock-market targeting and excess capacity. Politics and economics often
    work at cross-purposes. America can ill afford such an outcome today

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