US Economy: Strong or House of Cards?

Dear Gavin:

Let’s start one up to see where the economy is going. This might be an interesting subject to follow up on and I would like to hear your views particularly since the US is now running current account deficits of more than 5 percent. Many in Southeast Asia collapse when hitting 4 percent.

If you want to convince me the US economy is introuble you’re going to have to do a little better than that.

Actually Gavin Januarus and I were discussing the subject tangentally in another forum and decided to raise the issue on a separate thread. The first comment was merely a brief observation on our way to it is hoped greater discussion. Rather than look at it as a convincing argument, how about supplying your views, preferably backed with facts and cogent arguments, in the meantime?

The American economy is one built more on hopes and dreams than on any coherent economic theory and/or fundamentals, such as current account surpluses, deficits, debts, and so on. American power (military/social/cultural/etc) colors the way people see America and view its financial position vis-a-vis other countries. People think America is strong because America dominates all other countries in the world, so of course the economy must be strong too, so American politicians/captains of industry can raise the money needed to finance economic expansion based on that illusion, both domestically and internationally. If America uses that strength, more people buy the dollar/invest in America and the economy benefits even more. If people see America as weak, for whatever reason, then the economy tends to suffer. Has been that way since the War of 1812, and will continue to be that way until America tries to do something it fails miserably at, such as another Vietnam War … IMHO, of course. :slight_smile:

I just returned from a weeklong business trip to Indiana and Michigan where I visited a dozen truck, car and farm equipment factories – the heartland of American manufacturing. Everyone there (ie. the bosses) agreed that this downturn is different from any in the past in that the jobs that are being lost this time aren’t coming back. In other words, this time it’s not a ‘downturn’ with just a few job losses with most reappearing when times get good again; it’s a permanent mass exodus.

The bosses’ message to me was uniform from plant to plant. Help save our jobs at least by trading our American workers’ jobs for lower-cost Asian suppliers. This would have been heresy five, ten years ago among management in the US manufacturing heartland but the times they are a’changing.

The American workers who are losing their jobs will end up working at lesser paying jobs distributing and selling the products from Asia that they used to make themselves. Their industrial skills and means of production – the seedcorn of American industry – will be lost and it will be exceedingly difficult to ever reclaim them.

Can a country whose power and prestige flows fundamentally from the prowess of its manufactured weaponry survive without a healthy manufacturing base? Is the emperor really strolling past me stark naked?

Whilst the leadership of America is fixated Don Quixote-like on its borrowed quarrels in the Middle East, the sands beneath its feet are eroding in the swift currents of global competition. Like fishermen too intent on catching the big one, they’ll find themselves underwater and far from shore before they realize it and no tax-cut lifevest will save them from their fate.

I have a varying opinion from that put forth from Gavin Januaras.

I agree that we are in a bad economic downturn. We have a glut of manufacturing in the world. I say as bad as it is in the US, it’s worse elsewhere. I believe we are facing the “perfect financial storm” along the lines of the Great Depression. If deflation hits the US, like it has Japan, then it is quite simply “game over.” Here’s some facts and my reasoning.

US corporations are in their most indebted state ever. Their pricing power is quickly being eroded in some industries, complicated by regulations that reward failure. The bubble market of the late 1990’s wasn’t only in stock but also in corporate debt. As this debt matures, companies are finding it hard to roll this debt over at an acceptable interest rate. Banks are becoming quite tight fisted and secondary equity offerings are currently out of the question as they would lead to what is now believed unnecessary dilution of the owernship interest at inadequate prices. In two years, I believe you’ll see a lot of companies wishing they had done the equity offerings now. This leads to “fire sales” where quality assets can be bought on the cheap, if anyone even has the money to buy them. Chapter 11 bankruptcy is really being abused lately by airlines and telecommunications companies. Out of all the countries in the world, I think the US is the best positioned, due to consumer demand oriented, not export demand oriented. It also has the fewest regulatory problems, most transparent financial markets, and world’s biggest exporter and importer of goods by a couple factors. Also in the industries that the US dominates, wages are not an issue, infrastructure is in place, and required skills only adequatedly supplied or obtained in the US. I think trade disputes will get more press as manufacturing suffers in the US.

Japan and the rest of Asia might someday realize that foreigners and foreign products are desirable for the economy. They might learn about this mysterious thing called “consumer demand.” This means not jacking your own citizens by forcing them to only buy from gov’t sanctioned and endorsed monopolies/cartels, but actually offering them a choice. This is where we are going to see some real pain if the US economy goes south. All those factories and workers idled because they’re products aren’t being bought. People might argue the China point, but I feel it’s a non-issue for a country that purposely manipulates its economy. We are just one financial disaster from watching everything being nationalised in China. I don’t think people realize exactly how much control the government has in business in Asia. Currently it is cheaper by a factor of 100 to form a corporation in Hawaii for Japanese citizens doing business in Japan than it is for them to just form the corporation in Japan for the same purpose.

Africa is a non-issue, just above Antarctica and just below the Middle East. It will be interesting to see how the US affects OPEC with its influence in Iraq in the next 2-5 years.

Europe is a house of cards in my opinion. The Lisbon Accords are quietly being dropped as we speak. Europe has significant structural problems without the will to quickly implement necessary action. European companies were on a similiar big debt binge as their American counterparts, just without the equity abuses. The British are doing well, just need a weaker pound. France is facing some serious problems, due to opposition to the US-led war in Iraq. It’ll be interesting to see how Chirac handles it. People like to point out how he got 80-90% of the vote in the last election, but fail to mention his challenger was similiar to a French clone of Ariel Sharon(who makes GWB look like a peace loving hippie). Schroeder is a lost cause. Hopefully Germany has the fortune to have it’s PM have a heart attack and die quickly. Here is a man who completely dodged Germany’s many problems, admitted that if he didn’t lower Germany’s unemploymant rate, he shouldn’t be elected and then just pandered to voters on a anti-US stance to get elected. He makes GWB look downright respectable IMO. This has gotten Germany the 3rd largest economy in the world where? Let me tell you, increased unemployment, possible deflation, and failing to meet the terms of its own idea the Economic Stability Pact(?). So business are closing and Germany is also losing its manufacturing base. I think the US could use a healthy dose of Europenaism, and likewise for Europe.

So unless the US picks up and I don’t see a quick turnaround. The US is the world’s economic superman. Basically as things look, we are in for a long economic downturn worldwide. The US will lose some manufacturing, but will also gain jobs in other fields. Unions are waking up to the fact that they are becoming irrelevant to their members if their members do not have jobs. I’ll be happy with 1% growth and no deflation for the next 5 years. Eventually I see a world where cost of capital and regulatory enviroment determine where things are made. I see a lot of dominance in this area for the US.

I think we have only seen the beginning of the problems. It was couple years after the 1929 stockmarket crash that the Great Depression got into full swing.


No, in effect, you visited one or two industries. Not representative of the economy as a whole. Yet, you felt you could extrapolate that to:

By what yardstick do you describe the US as a manufactring economy? This old chestnut about the loss of a manufacturing base has been trundled out for decades. The share of manufacturing in the US is in continual decline, but so what? If by designing and branding goods in the US, while manufacturing them abroad, we can make larger numbers of these goods more cheaply - then is not the world better off? Both the US and overseas? Of course it is.

The decline in manufacturing jobs as a % of the US labour market has continued for decades, just as the US economy continues to grow at the same approximate long-term pace that it always has. So, the manufacturing argument is not at all convincing. It is completely besides the point.

You may counter that it is not besides the point for those workers forced into lower paying jobs. And I would agree. But I would remind you that we are talking about the entire economy, not just workers in one industry.

I might also point out that the closing down of unprofitable industries and the importing of cheaper goods from abroad, paid for by the production of new industries set up at home is precisely the kind of economic model that has allowed the US and other open economies to grow.

And there is another basic problem - you extrapolate from a couple of industries to the economy as a whole. But you should be able to see problems in your reasoning which require further, more sophisticated explanation… (and one which I admit I cannot find for you).

If the whole economy is indeed how you picture it ( by extrapolation of the truck/agri-vehicle business situation) and:

Then how do you explain the current account deficit? A current account deficit is roughly equal to the excess of investment over saving in an economy. But if there is such a "mass exodus’ why does it not show up in the numbers? How can there be a continuing excess of investment over saving and a ‘permanent mass exodus’ of businesses at the same time? I think you do indeed mistake a (possibly prolomnged) recession for the End of the World.

As for the comparison with Asia 1998…Personally, I believe the c.a. deficit will shrink - and perhaps the dollar will weaken further, too. But its all part of the adjustment between saving and investment rates and need not precipitate a collapse. Asian countries c.1998 were far more vulnerable to currency devaluations because their corporations had large amounts of US dollar debt which it was hard to repay if their currency collapsed. But what does the US care if the dollar weakens? Most debts are in US dollars! Need more dollars? Greenspan will print some more for you. Its fundamentally different to the 1998 Asian crisis.

But sure, the US economy is weak and will probably go through a protracted period of slow growth as household and corporate debts are paid down and the government budget deficit has to be financed.

Okami’s points, though I may not agree with his views entirely, at least show some understanding of economics.

I saw an article in the China Post in 2001 November in Business Monday that was an interview with Jonathan Anderson at Goldman Sachs in Hong Kong.

He basically pointed out that while Japan has not hollowed out, neither has it grown. He pointed to Hong Kong which has hollowed out, but grown. Taiwan had hollowed out somewhat but still grown somewhat. So I understand that manufacturing is not important necessarily for high wage jobs. Problem is are we getting the kind of high wage jobs we need in the US? Is this irrelevant? Is this unavoidable? or are we in fact getting high wage jobs in other service sectors? Hope this makes sense.

Another point. Okay the US can print dollars whenever it wants because the debts are in dollars and thus insulated. How much longer can the US rely on having the kind of international currency that enables it to do so?

Finally, it seems that most of the economic problems the US faces are worse in other countries, i.e. Japan and Germany despite their better savings rates and current account surpluses. This may stem from their more rigid labor and business regulations and for the latter, higher taxes.

Should we then worry that the whole world is going to tip into deflation or is this something else that has been grossly exaggerated?

Quite right F.S. And G.J.'s favoured solution would have the US ploughing the Japanese furrow.

Not at all irrelevant. Yes, the US is getting high-wage jobs in sectors outside manufacturing. However, there is an increase in wage inequality. This is probably unavoidable - it seems the major culprit is technology, though there are some more complex suggestions to do with education-signalling. And, just to anticipate - no, G.J., trade with other countries is not a good explanation for rising wage inequality in practise.

Well, in fact, you don’t need to have an international reserve currency to be so “free.” The reason why so many Asian countries borrowed in US dollars was because their governments fixed exchange rates to the dollar. With interest rates in the US below those in much of Asia, it made sense to borrow US dollars SO LONG AS YOU BELIEVED THE EXCHANGE RATE WOULD ALWAYS BE FIXED. A floating exchange rate right from the outset would probably have made the risks of currency fluctuations more apparent to companies (though it brings its own problems). Companies in other nations have managed to avoid excessive foreign debt without having 'international currencies."

I agree.

high savings rates are only beneficial if they lead to high investment rates. Japanese savings rates seem to be high because of panic! its precautionary saving, not 'entrepreneurial" saving.

I think rigid labour markets contribute to inflexibility and therefore these economies adjust more slowly. C.A surpluses - excess savings, are probably partly exacerbated by poor monetary policy (deflation) in Japan but maybe fundamentally caused by structural and demographic factors - rapidly aging society, unlike the US which is being kept young by immigration.

Its worth worrying about. In theory, you just keep expanding the money supply until you create inflation. But if people are willing to hoard the extra money (hide it in their mattresses) it makes deflation a little harder to fight. (I note, however, that some price indices may be turning around in the US.)