From the October 23, 2007 Sunday Times (London)
October 23, 2007
by Irwin Stelzer
Last Friday was the twentieth anniversary of the stock-market crash of 1987, when the Dow Jones fell more than 500 points, or 23%, in a single day. That was almost 60 years after the great crash of October 1929, when share prices also fell 23%, but over a two-day period.
Here we are in October 2007, experiencing a credit crunch that has forced some big banks in America to form a $100 billion bail-out consor-tium to avoid a fire sale of troubled financial assets in which they are heavily invested, with Citigroup the most exposed. The deal was hammered out at a meeting convened by Treasury secretary Hank Paulson and put together under the watchful eye of his top aide, Bob Steel. Gold-man Sachs, where both men earned their spurs before joining the government, comes to Washington.
Paulson, it seems, has become worried about the economic outlook. He told students at George-town university that “the ongoing housing correction is not ending as quickly as it might have appeared late last year . . . and it now looks like it will continue to adversely impact our economy . . . for some time”.
He is right about the housing market. Rising inventories of unsold homes have driven new construction to a 20-year low. Some 200,000 workers in the residential construction industries have been laid off, as have thousands more from firms that write and service mortgages. Some 1m sub-prime loans are at least 30 days’ delinquent; more will be added to that list when 2m sub-prime loans are reset to higher interest rates in the next 18 months. Repossessions will follow.
That much is clear. What is less clear is the impact the housing market will have on the broader economy. Paulson is right that the economy is slowing, as the Federal Reserve’s recent survey of its 12 regional districts confirms. But slowing to perhaps 2% growth is not a recession. Growth in the construction of commercial properties is picking up some of the slack in the residential sector. Exports are growing at a double-digit rate, buoying industrial output, which rose at rate of 4% in September.
The export boom is likely to continue. For one thing, the world economy is set to continue growing, at the quite satisfactory rate of 4.8% in 2008, according to the International Monetary Fund. For another, the weak dollar is making American goods cheaper overseas, and diverting US consumers from, for example, expensive European hotels to Florida, California, and in some cases American cruise ships that gladly take their dollars. Indeed, the finance ministers and central bankers from the industrialised nations who descended on Washington last Friday for their annual meeting expressed more than a little annoyance with a $2 pound and a $1.43 euro that is starting to hurt exporters and tourism in Britain and in euro-land.
But American exporters are smiling. So when Bush administration officials reiterate the standard position – a strong currency is in America’s interest – take it with more than the usual pinch of salt. Many in the administration would like to see the dollar weaken further or, as they would put it, they want other currencies, most notably China’s, to strengthen against the dollar. Indeed, nobody in the American government would mourn if the currency fell to $1.50 to the euro, and $2.15 to the pound. Domestic economy up, trade deficit down. And right before the 2008 presidential and congressional elections.
Meanwhile, unemployment remains low even in the face of slower hiring, and real wages continue to rise. Consumers continue to spend. September sales were up 2.7% on last year, adjusting for inflation, even though retailers were hard hit by warm weather that made it difficult to move autumn clothes. Even sales of cars proved a pleasant surprise.
It may well be that the pessimists have overstated the impact of the mortgage and housing-market problems on the economy. Investors seem to think so. Share prices are above the levels at the start of the year, because the Fed is in a rate-cut-ting mood, and because earnings of companies such as Intel, Yahoo, and even JP Morgan are surprising on the upside.
It is important to keep fear of interest-rate resets and home repossessions in perspective. The mortgages of the great majority of American homeowners are on long-term fixed-interest rates – no reset problems there. The drop in home values means some people won’t be able to use their residences as cash machines for a while, but most are still way ahead of the game: their homes are worth a lot more than when they bought them. Throw in the fact that the average value of shares has increased by 70% in the past five years, and almost 6% since the start of this year, and you have an anomaly. Consumers tell poll-sters their confidence is falling while their balance sheets are in great shape, their incomes are rising, and they continue to spend.
A similar anomaly exists in the business sector, where chief financial officers profess to be worried about the general economy, but confident enough in their own companies’ performance to continue with most capital-spending programmes.
This wouldn’t be an article about economics if there were no “on the other hand”. Oil prices have hit $90 a barrel and credit markets, although improving, remain fragile. Unemployment is likely to increase. A leading financial institution might implode. Investors are dumping American securities. That’s why Fed chairman Ben Bernanke said the outlook “for the broader economy remains uncertain”. But as the man said after jumping off the 102-storey Empire State Building, “So far, so good.” He had reached the fiftieth floor at the time.
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.
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