here are new pressures on the economy that are raising risks to the sustainability of the recovery. However, the strengths of the current economic situation will be able to bear the burdens.
While we must remember that we're emerging from the Great Deflation of 1997-2001 and that takes time we are also blessed with a flexible labor force and a relatively low unemployment rate at this point in the recovery. We're in good shape.
Still, the headlines are only accentuating the negatives in particular, Washington leadership problems and malfeasance at big corporations. But the economy remains strong at so many levels: individuals are producing, small- and medium-sized businesses are growing, and innovation reigns. June showed strong gains in U.S. industrial production, very low inflation, and further declines in jobless claims.
As for the reeling stock market, government policies are more important than abstract confidence in equities and corporate management. The Great Depression involved a series of massive government mistakes on tariffs, taxes, the banking system, and foreign policy. The bad equity market of the 1970s was a response to bad government, too. At the time there was a massive dollar devaluation, wage-price controls, inflation, staggering tax rates, and on and on.
In 2000, the major government policy mistakes that could bring on a global recession were evident. There was deflationary damage from the ever-strengthening dollar. There were overly tight central banks in the U.S., Europe, and Japan. Our government maintained a tolerant attitude toward oil-price manipulation by OPEC. And then there's the little detail of the near-record U.S. tax burden.
The current policy mistakes are not as dramatic as those in 2000, and much less than those of 1929 and 1971. And the heavy burdens facing the global economy are correctable in the event that we see some economic leadership from Washington on the following fronts:
The Dollar Trend. As a currency weakens, it discourages investment by creating uncertainty about the future exchange rate. Worries about a downward float in the value of the U.S. dollar have already hurt equity markets and, on the margin, are beginning to have an impact on the U.S. cost of capital and the investment rate. A July 18 Bloomberg story began: "Japanese investors' plans to move money to the U.S. in the fiscal year that started April 1 vanished faster than you can say WorldCom Inc. The potential for a weaker dollar, they say, is making them keep money at home."
The Bush administration's
dollar position has been interpreted as a full acceptance of a weakening
dollar trend. The
Expensive Oil. The price of oil touched $28 per barrel on July 19. Future oil (December 2003) is at $24.50. In an April Wall Street Journal interview, President Bush correctly identified expensive oil as a risk to the economic recovery. However, to date U.S. diplomatic efforts with OPEC and its allied producers like Mexico and Norway have been ineffective.
Litigation Risks Post-Enron. The new Senate accounting bill expands civil penalties relating to various business practices. In recent weeks, equity markets have reacted very negatively to each hint of advantage for the Senate bill over the House bill. Given the easy congressional victories for the trial lawyers on the terrorism-insurance bill and efforts to rationalize the asbestos lawsuits, the Senate bill poses a credible new economic threat.
As President Bush puts pressure on Congress to finish the House/Senate conference fast, it has seemed to increase the risk of a harmful bill with regard to civil litigation. However, the administration will have substantial leverage in the conference, and should be able to reduce the damage.
Trade Problems. Congressional progress on the Smoot-Hawley protectionist legislation preceded the 1929 stock-market crash. In 2002, Trade Promotion Authority is stalled in a House-Senate conference, weighed down by deeply protectionist provisions added in the Senate. Conferees may be able to repair the legislation in some ways, but the market risks include further delay and the possibility of a harmful or mediocre bill.
The Bush administration's steel tariffs, meanwhile, continue to rile U.S. trading partners without delivering political or economic benefits at home. The administration would get more economic and political gain from leading in a different trade direction.
Another Japanese Recession. As the world's second biggest economy, Japan's growth is important to the strength of the U.S. recovery. In addition, Japan has become a black hole for world capital, soaking up trillions of dollars at a 1.3% yield. The cause of Japan's economic malaise is bad monetary policy, which could be influenced by a clear U.S. message. Unfortunately, Japan's central bank recently sterilized its foreign-exchange interventions and reduced its holdings of Japanese Government Bonds, setting in motion another deflationary downturn.
Japan's economic positions worsened markedly at the time of the recent Presidential Summit in Canada. The Bush administration could help rebuild market confidence by encouraging Japan to stop its deflation by using proper monetary policy.
Sovereign Debt Defaults. Under IMF guidance, Brazil is on a path to default. This is contributing to economic and political turmoil across South America and threatening another lost decade like the 1980s. Recent comments by Bush-administration officials suggest complacency and a reliance on IMF austerity policies. But upcoming visits by U.S. and IMF officials will provide an opportunity for a 180 degree change toward growth-oriented economic policies.
Historically, bad equity markets are often responses to bad governing. Vocal and correct positions by the Bush administration on the dollar, trade, post-Enron repair, and world markets will not only help keep us moving along this bowl-shaped recovery, but will help return confidence to the critical American investor class.
Mr. Malpass is the Chief International Economist for Bear Stearns.