Terrorism, debt, the oil crisis and Hurricane Katrina. Larry Elliott reflects on how the US deals with its crises
Four years ago the dust was still settling on Lower Manhattan. The Twin Towers of the World Trade Centre had been reduced to rubble and the United States was in shock. Rightly, there were fears for the health not just of the US economy but also that of the rest of the world.
The terrorists had chosen their moment and their target well. Following the raging stock market boom of Bill Clinton’s second term, the dotcom bubble had been well and truly burst. On September 10 2001 there was already the sense that Wall Street was suffering from the sort of hangover you get after a party that has been allowed to go on way too long. Two days later, it was appropriate to speculate whether the global economy would recover from this attack on its pulsing heart. And yet it did recover.
To be sure, Wall Street was closed for the rest of the week and, on re-opening, fell through the floor. But there was no total meltdown. To be sure, the economy went into recession, but this was no repeat of the early 1930s. Indeed, the notable thing about the recession was just how short and shallow it proved to be.
All this needs to be borne in mind when contemplating the impact of Hurricane Katrina. The US economy is constantly being written off and constantly defies the sceptics with its ability to bounce back from just about anything that is thrown at it. Economic policy certainly plays its part in keeping the show on the road, and it was clear last week that no expense will be spared in the reconstruction effort for New Or-leans and the rest of the Gulf coast. This is a time when America’s cavalier approach to budget deficits is a definite advantage, and just as Congress voted money for the war in Iraq so it will approve the $50-billion requested for the southern states.
There’s more to it than that, though. The evidence shows that US companies tend to be better managed than those in the rest of the world (and considerably better managed on average than those in the United Kingdom), while the sink-or-swim nature of the US welfare system leaves those down on their luck little option but to find a way to make ends meet.
Despite the rudimentary social safety net and the pockets of poverty, the default mode for the country is one of optimism. Setbacks are dealt with. People generally expect life to be better next year than it is this year.
So in the medium term there is good reason to be upbeat about the US. The water will be pumped out of New Orleans, the city will be rebuilt and consumers will return to the shops. This is not the moment when we witness the final collapse of the American economy, even though there are plenty of people on the other side of the Atlantic who would dearly love that to be the case.
In the long term, of course, it may be a different story if the US, along with the rest of the world, runs smack up against environmental constraints. But do I see a return to the 20%-plus unemployment of the Great Depression when I envisage America in four years’ time? No, I do not.
What I do expect, however, is a pretty bumpy ride, not least because the US economy has been living on borrowed time ever since 9/11. What happened was pretty straight-forward: the Federal Reserve sanctioned a cheap-money programme that encouraged consumers and businesses to borrow and spend.
One look at the housing market shows just how this injection of liquidity into the financial system has prompted a raging property boom. Sales of homes have been running at record levels this year and price inflation is about 13%. Alan Greenspan cured the hangover from the demise of all those worthless dotcoms by starting an equally raucous party in real estate. George W Bush chipped in by cutting taxes and raising spending on defence. Before Katrina struck, Greenspan was already making warning noises about what would happen when the housing bubble bursts as, given the extent of the over-valuation of real estate, it will at some point.
So it will be fascinating to see whether in his last few months at the Fed he calls an end to the gradual tightening of monetary policy that has seen interest rates rise from 1% to 3,5%. The chances are that the Fed will now be far more wary about raising rates — although some commentators believe Greenspan will want to show his faith in the US economy by raising rates again later this month — but there will be none of the aggressive easing of policy that occurred after 9/11. Should there be a return to the so-called ”Greenspan put” — the notion that the Fed would always act to prevent the stock market or the economy suffering too bad a knock — it would be a serious policy error.
As the analysts at Capital Economics point out, 9/11 was a demand shock that could be confronted — at least in the short term — by cutting interest rates to boost confidence. Katrina is different. It is a supply shock, with the price of gasoline high for the very good reason that demand is strong and 10% of America’s refining capacity has been knocked out.
What the Fed should be hoping for is what — so far — appears to have happened in the UK, with a gradual and modest tightening of policy leading to a soft landing in the housing market. A bit of belt-tightening from US consumers in the face of dearer energy costs would be helpful in that it would prevent interest rates from going much higher. The risk is that Greenspan seeks to compensate consumers for the effects of Katrina by loosening policy, and thereby gives extra momentum to an over-heating housing market. That will inflate the boom, and the bigger the boom the bigger the bust.
The last thing US consumers need at present is to take on more debt: their balance sheets are already stretched. Goldman Sachs was right last week to suggest that the impact of Katrina on consumer spending could be transitory.
”A likely pause in Fed tightening and a massive reconstruction programme ramping in early 2006 should increase next year’s growth. A $10,5-billion ‘down payment’ from Congress is already on its way and insurance claims are now estimated to approach $30-billion. The positive impact could be more than one percentage point for much of 2006, more than offsetting the 2005 hit.”
The dangers, however, are twofold. First, there is a risk that supply shortages might persist, pushing up prices still further and perhaps leading to hoarding and rationing.
Oil prices could then spiral upwards, giving a real body blow to consumer confidence and jobs. As Goldman Sachs says in its research: ”A localised regional tragedy could turn into a global issue accordingly.” The other risk is that Greenspan was already running out of road before Katrina. There are no more bubbles to be inflated once this one has been popped. A period of slower growth for the US is both necessary and inevitable. — Â