Tangle of Weeds Awaits to Strangle U.S. Green Shoots

America will not go bust. At least not in the sense of being unable to cover all the IOUs it has peddled to China and other investors. Hidden in some Washington basement are the printing presses that turn out dollar bills on command. So if America's creditors turn nervous or nasty, the Treasury can always crank up the presses, produce new bits of paper adorned with pictures of American presidents, and redeem its outstanding notes and bonds.

Which isn't much comfort to those holding our IOUs, since the bloated supply of dollars would have a lot less purchasing power than those the creditors lent to us. That's why China and other countries are searching for ways to avoid piling up more Treasury bonds. This won't be easy: they need to keep selling their goods here to provide jobs at home, and prevent simmering social unrest from coming to a boil. That partly explains the recent weakness of the dollar. But only partly. The world economy is becoming less scary, and investors are more inclined to take risks and less inclined to seek a haven in US Treasury IOUs. The world financial system will not implode, thanks in part to vigorous government actions to shore up banks. Give Gordon Brown credit: he led the parade of bailout governments.

In America, most banks passed the "stress tests" - which observers say were not very stressful - with flying colours, and those that did not (Citigroup, Wells Fargo, Bank of America) are raising capital to bring their books up to snuff. Almost all leading banks want to repay the money that some begged for and others had forced on them by then-Treasury secretary Hank Paulson. Nothing focuses a banker's mind like bonus restrictions.

None of this means the American banking system is out of the woods. The regional banks are heavily invested in mortgages on commercial properties. The Lindsey Group estimates that about half of the $500 billion in commercial property debt that needs to be refinanced in the next two years "will not be able to be refinanced or rolled over on the same terms. Keys to thousands of properties will be given to creditors and fire-sales will become more common". That figure is roughly in line with the estimate of Richard Parker at Deutsche Bank. This is why triple-A rated bonds backed by mortgages on commercial properties are yielding more than 10%.

Meanwhile, many of the professional firms that had been competing for prime office space in Manhattan, Chicago and other cities are no longer in expansion mode. Indeed, many are trying to sublet unneeded space, in the process driving down rents - three out of every four office towers in Manhattan have sublet space available.

Then there is the housing market. House prices are now about 20% below last year's levels in most markets, and dropping. Even New York City, once considered invulnerable to falling prices, is feeling the pinch: residential rents are down about 7%, and the posh Hamptons house that commanded a two-month summer rental of about $230,000 last year can be had this season for a mere $175,000.

Even more worrying is the macroeconomic outlook. The federal debt, which once stood at about 40% of GDP, is budgeted by President Barack Obama to rise to 80% in 10 years, and is expected by many observers to hit 100%.

Economists guess that such a high debtto-GDP ratio will drive interest rates up by somewhere between 1.25 and 1.5 percentage points, slowing the economy to a crawl. An alternative, says Stanford professor John Taylor, would be to inflate our way out of the problem - which would take a 100% rise in the price level over a 10-year period. Unless, of course, there is truth in the rumours that the administration is planning to cut into the deficit by introducing a national sales tax - Vat by another name.

This tale from the dark side is designed to alert those who see abundant green shoots that there are still plenty of weeds to strangle healthy growth.

The better news is that groups of investors are bidding vigorously at auctions for repossessed houses. They are buying hundreds of such homes, then renting them to the previous owners at rates the tenants can afford, and at the same time yield a decent return to the investors. Add first-time homebuyers who are now priced into the markets from which they were previously excluded, and you have the beginning of a reduction in the inventory at the bottom end of the market.

There is also evidence that low interest rates and bargains are luring buyers at the higher end back into the market. That is why the recent declines in home construction have been confined to multi-family dwellings. Construction of single-family homes rose slightly in March and then by a more significant 2.8% in April.

That development is consistent with the latest data on consumer confidence. The Conference Board reports that its index of consumer confidence jumped from 40.8 in April to 54.9 in May, the largest one-month increase since 2003, and the highest level in eight months. The rising stock market is buoying confidence, and that rising confidence is driving up share prices. The new, rosier view is also due to the fact that the jobs market is not deteriorating at the rate it was a few months ago.

What to make of these contradictory data? I have always found that it is a good idea to go to the people at the hard end of a recession - retailers. So I spent a week in New York talking to retailers, and have been listening to others here in the Washington area: clothing stores, costume and high-end jewellery shops, furniture and antique dealers and wine merchants. A few say business is terrible. But most - the vast majority - tell the same tale. Business fell off a cliff last October, and then stayed at levels that had many considering going-out-of-business sales. But in April business picked up, and has continued to improve in May. I would describe the general mood as cautious optimism.

Which is about where I come out.