Presidential Baptism by Fire

Americans now know everything about the economy that they will know by the time they go to the polls to choose between George Bush's continued stewardship and John Kerry's plan to return the Clinton economic team to the White House.

Late last week the government announced that the economy grew at the satisfactory rate of 3.7% in the third quarter, with consumers again leading the way.

That buoyed the president's men, who are on the hustings reminding voters that sales of new homes in September rose by 3.5% to the third-highest level on record; that orders for durable goods rose last month; and that business spending rose in the third quarter for the sixth consecutive quarter -- and by a healthy 11.7%.

With autumn harvests "ahead of the normal pace," according to the Federal Reserve Bank's latest survey of business conditions, even usually-grumpy farmers should be happy. All in all, said the Fed, "Reports from the 12 Federal Reserve districts generally indicated that economic activity continued to expand in September and early October."

The Bush team also points out that the unemployment rate is at a low 5.4%; that the economy has added 1.7 million new jobs in the past year; and that workers are better off because their pay has risen in the past year by 1.2% more than inflation. Not a bad recovery from the devastating effects of September 11, 2001.

Kerry's team counters that Bush is the first president since Herbert Hoover to preside over a net loss of jobs. They also claim that Bush's massive tax cuts did nothing to ease the squeeze on middle class families. These Americans, says Kerry, are caught between a weak labor market and the rising cost of healthcare and college tuition. Throw in an increase in the recorded number of people living in what we define as "poverty," and you have Kerry's indictment of the Bush economic policy.

How much of this will matter tomorrow, nobody knows. Some voters are more driven by issues such as abortion, gay marriage and the place of religion in political life than they are by pocketbook issues. Others, perhaps most, will base their votes on their views of the situation in Iraq, with reports from a largely pro-Kerry media about missing explosives, 100,000 civilian deaths in Iraq, and continued abductions and beheadings drowning out news of progress in Afghanistan and large parts of Iraq.

A few -- very few, I would guess -- will be asking themselves which of the candidates is most able to cope with the now clearly visible economic storm clouds. The recent downward drift of the dollar may be signaling the end of an era in which America could, and did, live happily off the savings of other nations.

The facts are these. America's trade deficit has passed the 5% of GDP that most economists feel is unsustainably high, and is headed to 6%, in part because the import bill has been swollen by high oil prices. To finance that deficit, America has to borrow from China, Japan and other foreigners by selling them American shares and bonds, including bonds issued by the Treasury. Foreign governments, led by China and Japan, now hold $1.2 trillion in Treasury IOUs, and have a tiger by the tail.

If they increase the downward pressure on the dollar by refusing to buy new Treasury bonds, they will drive down the value of the IOUs they already hold.

Still, the fact is that these lenders seem increasingly reluctant to buy American securities.

They have reason to worry. The dollar is sinking against both the euro and the yen. Japan's finance minister has passed the word that he is prepared to intervene in currency markets to prevent the yen from rising sufficiently against the dollar to threaten Japan's export-led recovery.

China, meanwhile, continues to peg its currency to the dollar, so that no matter how low the American currency sinks, Chinese exports will not become more expensive in America, or American exports cheaper in China. This is also bad news for euroland and Britain, because the euro and sterling will bear the brunt of the dollar's fall, reducing the competitiveness of European and British goods in the American market.

There is worse. If the downward drift of the dollar turns into a precipitous decline, Alan Greenspan, Federal Reserve Board chairman, would have to raise interest rates so that foreigners would be willing to buy and hold Treasury bonds.

Higher interest rates will cut into business investment and put further pressure on debt-burdened consumers, already hit hard by the rising price of gas and heating oil. Result: an economic slowdown.

All of this means that whoever wins tomorrow’s election might wish he hadn't.

Unless, of course, he is able to tackle the government deficit by cutting back spending, pressing the Chinese into floating their currency and the Japanese into allowing the yen to appreciate against the dollar, and persuading European policymakers to stimulate the region's economy so that it exports less to and imports more from America.

Fat chance. Congress has just passed a pork-laden spending bill that represents the triumph of business lobbyists over fiscal sanity, domestic pressures are forcing the Chinese to create millions of jobs by stimulating exports, and European policymakers are unwilling to adopt reforms that would enhance growth. So the next American president may have to deal with a dollar debacle. Or worse.

The economist John Makin said: "If oil stays above $50 a barrel beyond the end of the year, a recession is likely to occur in 2005."

That would bring a grim smile to the lips of either the new full-time resident of Crawford, Texas, as he clears away the brush on his ranch, or of a Massachusetts senator with the leisure time to pursue his hobbies of wind-surfing and snow-boarding.

A version of this article appeared in the October 31, 2004 Sunday Times (London).