Buoyant Growth Trips Up the Doom-Mongers
February 5, 2007
by Irwin Stelzer
It seems the apocalypse has been postponed. Just a few weeks ago there was an emerging consensus that the American economy in 2007 was doomed to below-trend growth at best, and a recession at worst. The tale of woe went something like this.
The housing market was in a state of collapse. Never mind the figures suggesting sales were recovering, or that the Federal Reserve Board's analysts saw signs of stabilisation in the housing market: the data didn't reflect the large number of contracts that had been cancelled as speculators and prospective homeowners walked away from their deposits. Lay-offs in the construction industry were sure to follow. Worse still, with house prices dropping like stones, consumers would no longer be able to borrow against the rising value of their homes to finance trips to the malls. Wallets and purses would be zipped, and the economy would stall.
That would create pressure on the Fed to cut interest rates. But it would be unable to oblige with that shot in the arm. A falling dollar would push up inflation by raising the price of imported goods, and easing the pressure on domestic producers to keep prices down. Meanwhile, an anti-business Congress would be attacking "big business", causing chief executives to trim their companies' investment programmes. Add a Congress flirting with recession-encouraging protectionist measures, and you had apocalypse now.
A funny thing has happened on the way to that disaster. Instead of declining to below the third-quarter rate of 2%, the rate of economic growth in the fourth quarter of 2006 is estimated to have come in at a healthy 3.5%. Instead of retreating from the malls, consumers continued to spend, proving once again that nobody ever got rich betting against the American consumer. Instead of collapsing, the dollar has merely drifted down, spurring exports (up 10%) and causing imports to fall (by 3.2%). This might, just might, be the first sign that the trade deficit is beginning to return to sustainable levels.
Equally important, the upward path of oil prices, predicted by many to end with economy-stagnating $100-a-barrel oil, was interrupted by a drop in consumption - higher prices matter to consumers. This caught the attention of the Saudis, who are increasingly nervous that the western consuming countries finally mean it when they say they will develop technologies and policies to begin the long process of withdrawing from total reliance on Opec oil. Like all sensible analysts, the Saudis know that President George Bush's proposal to convert most farms to biofuel crops is more a political crowd-pleaser than anything else, and that "oil independence" is a myth that American politicians have repeatedly set as their goal, only to watch reliance on imported oil rise from 35% to 60% of total consumption.
But the mere possibility of the implementation of programmes that will slow the growth of demand has been enough to make the Saudis promise to keep the price of oil at about $50 per barrel, rather than the $70 that their hated rivals, the Iranians, are calling for and the level that Hugo Chavez desperately needs to shore up Venezuela's shrinking economy. The Saudi royal family has decided that $70 oil, headed to $100, will hasten a nuclear-ethanol-and-conservationist future that will leave them scratching around to pay for the lifestyles of their 5,000 profligate princes.
It is true that the Saudis have recently cut output by about 1m barrels a day in the face of rising inventories, driving the oil price to above $55 a barrel. But they have made their point: anyone investing in alternative fuels faces the risk of Saudi price-cutting that will make such investments uneconomic.
Meanwhile, Fed watchers who confidently predicted a slow-down was upon us, and that it would force the Fed to cut short-term interest rates by mid-year, have gone back to their models to seek reassurance or to make changes in the inputs. It seems higher-than-forecast growth has not triggered a new round of inflation.
"Price and wage data," report economists at Goldman Sachs, are "more benign than expected on balance."
As a consequence, the Federal Reserve Board's monetary policy committee did not raise short-term interest rates last week. Instead, it held the line at 5.25%, but maintained a wary eye on incoming data, ready to act if the strong economy show signs of triggering inflation.
If all this sounds to you like Rosy Scenario is back on the economic scene, you are no different from American consumers. Consumer confidence is at its highest level in five years, reports The Conference Board, a private research group. If you want to know why some critics of the liberal American media accuse it of peddling unremitting gloom, consider this headline in The New York Times, "A Rise in Consumer Confidence May Not Last, A Survey Suggests". Rather than emphasise the five-year high in confidence, the paper picked up an Associated Press report that found significance in the fact that those who expect business conditions to worsen increased from 7.8% to 8.0% of those surveyed, and those who expected an improvement decreased from 16.7% to 16.2%. Never mind that these numbers show that twice as many of those surveyed expect business conditions to improve as expect them to worsen.
A strong job market, good economic growth, low inflation, and oil prices off their peaks are a wonderful offset to falling house prices and unhappiness about Iraq.
That does not mean the economy might not yet be in for a bit of a bumpy ride in coming quarters. But it does mean that even if 2007 proves not to be the very best of times, it will certainly not be the very worst of times.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.