FWIW:
America's optimism put to the test
By Alan Beattie
Published: August 2 2002 20:17 | Last Updated: August 2 2002 20:17
For a group with a reputation for inactivity, the Bush administration's economic team has suddenly burst into extraordinary life. The news that US output has suddenly slowed barely had time to flash up on traders' screens this week before Paul O'Neill, Treasury secretary, Lawrence Lindsey, White House chief economic adviser, and Ari Fleischer, President George W. Bush's spokesman, turned out in force with assurances that recovery was on track.
Behind their spurt of energy lie growing fears that, having weathered global financial crises, a near freeze-up in capital markets and a devastating terrorist attack during the past five years, the American consumer will fall victim to the simplest and most obvious shock of all: a correction in share prices.
The worry is that the turbulent financial markets are weakening the real economy - that having seen one class of their assets shrink, consumers will cast a critical eye over their considerable indebtedness and decide it is time to tighten their belts.
The administration's rule of thumb is that each dollar decline in stock market wealth takes 3-5 cents off consumer spending. The falls in equities during June and July, which wiped out about $1,600bn (£1,000bn), may take 0.5-0.8 percentage points off the growth in US gross domestic product, most likely over several years; not negligible but not catastrophic. Moreover, the effects may turn out to be smaller than the standard calculation implies. Consumption growth in the 1990s never kept pace with the rising stock market, implying households never truly believed their wealth gains were permanent.
Stephen Cecchetti, a former chief economist at the New York Federal Reserve, calculates that consumption equalled only 16 per cent of total wealth during the peak of the boom, well outside its typical range of 17.5-21.5 per cent, and that the recent falls have merely returned the ratio to a more normal level at the bottom of that range. That implies no further substantial correction to come. If consumers never changed their behaviour much when they were rich, the argument goes, they will not miss that paper wealth when it goes.
A bigger risk is that falling equities will trigger a sharp rebalancing in household budgets as families cut spending and instead pay off substantial debts.
Even allowing for a couple of one-off effects that depressed output, this week's data showed that risk had increased. Consumption slowed sharply in the second quarter of the year, with no sign of a broad-based pick-up in investment to fill the gap. Also, surveys of consumer confidence, though admittedly imperfect predictors of real behaviour that sometimes lag behind rather than lead the economy, showed heavy and unexpected falls. Savings rates have crept up to more normal levels, rising to about 4 per cent of income, but this is still less than half their long-term average. A further sharp increase in household saving would slam the brakes on what, apart from government spending, is the US economy's main engine of growth.
The hope for policymakers - and particularly the Federal Reserve - is that any slowdown in consumption is spread out over, say, five years, by which time companies are investing again. But as the Fed's latest "beige book" collection of anecdotal evidence suggests, there is scant sign of corporate investment's picking up the slack yet.
It is not that the levers of economic policy have ceased to work. Low interest rates have produced a spree of refinancing mortgages, putting money into consumers' bank accounts. As John Lonski, chief economist at Moody's, the rating agency, points out, a similar round of cheaper borrowing in late 1998 succeeded in keeping consumption going in the dark days after the Asian financial crisis and the Russian debt default.
Thus far, despite this week's GDP numbers, there is no conclusive evidence that households are behaving differently this time round. Car sales - sensitive to interest rate changes because of the credit used to buy them - are responding vigorously to a new round of zero- interest financing deals, rising 8 per cent in July on a year earlier. The Fed is hoping that the continued robust activity in the housing market presages a renewed surge of sales in consumer durables and home improvements in the autumn.
Mr Lonski also dismisses talk of a widespread credit crunch in the corporate sector. Large-scale reductions in loan availability, he says, are confined to stricken sectors such as telecommunications and energy trading. "There is a deterioration in credit quality but not enough on its own to block an economic recovery. The loans are there for most companies which want them." The corporate credit problem, he argues, is one of demand, not supply.
Herein lies the more intractable problem. Once consumers have decided, as companies seem to have done, not to spend even when money is extremely cheap, there is not much policymakers can do about it. Any boost to disposable income from cheaper mortgages and other borrowing might be saved, not spent.
Hence the clear aim of the administration's cheerleading: to persuade consumers who have slowed down to inspect the pile-up in the equity markets to turn their heads away and drive on regardless.
Publicly, the administration remains confident that households will not overreact to equity market turbulence and will make any necessary balance-sheet adjustments in a calm and steady fashion. Peter Fisher, undersecretary at the Treasury, says: "The US is a collection of the 280m most optimistic people from around the world." But a few months more of bad news on the economy could test that optimism seve
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