Rate cuts said inflating real estate bubble
Goldman report says lower U.S. dollar key to global recovery
Jacqueline Thorpe
Financial Post
Thursday, August 29, 2002
Waiting around for the U.S. Federal Reserve's interest rate cuts to finally pull the global economy out of its funk is going to achieve little more than replacing the equity market bubble with a housing bubble, a new report suggests.
Instead, as the spring recovery turns into a summer slump, policy makers need to get serious with a wide range of monetary and fiscal policies that will spread the burden for jump-starting growth away from the United States to the rest of the world, economists at Goldman Sachs said.
As Goldman sees it, U.S. interest rates of 1.75% are only fanning the flames of an unsustainable housing boom while doing little to recharge the battered corporate sector.
"In fact, in some ways, the current policy prescriptions are worsening the underlying problem," Jim O'Neill, Goldman's chief economist based in London, and William Dudley, chief U.S. economist in New York, said in their report: The Global Economy Adrift: Time for a Fundamental Shift in Policy.
"In essence, a mortgage debt bubble is being created to take the place of the equity market bubble that preceded it."
The duo argue policy should be orientated to facilitating a rise in household saving, a deleveraging of U.S. household and corporate balance sheets and an improvement in U.S. trade. The goal should be to get foreign demand for U.S. goods and services to fill the vacuum created by the evaporation of private sector activity and investment.
Among the policies Goldman advocates are a further depreciation of the U.S. dollar either through a change of official rhetoric or co-ordinated central bank intervention, or both.
Indeed, despite all the talk that this year's swoon in the U.S. dollar heralded a long-expected retrenchment in the greenback, it appears to have put in a bottom since the middle of July and is off just 10% against the yen and the euro. On a trade-weighted basis against the major currencies it is down about 6%.
Goldman says a further 15% to 20% fall in the dollar would not only ease U.S. financial conditions but also put pressure on other countries to ease policies.
And while a falling dollar may push up inflation in the United States as imported goods become more expensive, that would be a good thing for a country dancing on the edge of deflation. The Fed estimates a 10% drop in the dollar would raise consumer prices by about 0.4%. Goldman adds it would also keep the core personal consumption expenditure deflator, closely watched by the Fed, in a 1% to 2% range. It is currently at 1.6% and there is a danger of it falling toward 1% this year.
At the same time China should unpeg its currency from the U.S. dollar and allow it to float higher. Otherwise if it fell in tandem with the dollar it would only putting pressure on Asian exports.
Europe should not sit back on its laurels either, the Goldman economists said. Indeed business confidence in Germany slid for the third month in a row in August, data released yesterday showed and overall growth for the euro zone is likely to be as mediocre as the United States' 1.1% annual growth rate in the second quarter and may trail it in the third.
Mr. O'Neill and Mr. Dudley think the European Central Bank should cut interest rates 100 basis points while governments should introduce stimulative fiscal policies, even if that means breaking covenants of monetary union that limit spending.
Finally, the United States should bring income tax forward but be more austere in later years, by making the elimination of the estate tax temporary for example.
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