Dear Agha Mehrdad: I enjoyed reading your article, entitled "Boom and Bust ". Your analyses are valid and possess professional quality. I totally agree with your not-so-promising prognosis concerning the US economic outlook. However, I would like to add a few points of my own in support of your arguments and/or in an attempt to offer alternative views.
As far as I am concerned, the so called stimulus package, proposed by the Bush administration, is nothing more than a too-little-too-late remedy. It may not have the intended effects envisioned by the administration. As you know, the disposable income is not the only determinant of consumer spending, albeit a key factor. For consumers to spend more money, especially on the big-ticket items, their expectations must also be favorable. Without optimistic expectations, the full increase in consumer spending, following the tax rebate, is only a wishful thinking.
Although, the index of consumer confidence showed a slight increase, from 87.8 to 88.6, a less than 1% increases for the month of December. I believe it does not mean much based on its sheer magnitude. The increase was perhaps due to the upbeat consumer sentiment during holiday shopping season and the massive discount offered to them by retailers. I would expect the value of this index to drop noticeably for the month of January due the barrage of bad economic news that keeps coming.
In addition, the Purchasing Managers Index, PMI, which is a broad-based measure of producers' expectations and is based on a survey of thousands of supply professionals, showed a considerable decline for the same period of time, month of December. It dipped to 47.7%, from 50.8% the month before, a decline of 6.15%. Two of its five components; employment and the new orders declined for the month of December, the employment components was almost flat.
The value of PMI index below fifty, as you know, indicates that manufacturing sector is shrinking. And the prospect for new business investment is gloomy. In addition, when the PMI shows an unexpected decline, it triggers a strong negative reaction by stock market. The unprecedented drop in PMI was perhaps one of the contributing factors to the massive decline of the Dow Jones index since the start of the new year, about1000 points, or 7.5%.
Tax rebate in 2001 did not produce the desired effects either. According to a survey conducted by the Wall Street Journal right after the announcement of tax refund in 2001, 36% of the respondents indicated that they planed to save their tax refund instead of spending it. The attitudes may not be any rosier this time because of the lingering uncertainties coupled with the lackluster housing market and a severe crisis in mortgage industry. In my judgment, unless there is a drastic change, such as election of a democrat to the white house, there will not be a robust adjustment in consumer spending to the up side, we need a big push
2. Even though the United States is a supporter of the floating exchange rate regime, I believe it has been the hidden agenda of the current administration since President Bush took office to keep the value of dollar artificially low to boost the US exports. This policy has been to some extent successful thus far in keeping the US economy from falling into a severe recession.
3. It seems the ability of the Federal Reserve System to regulate the reserves of commercial banks through its monetary policy has been faded in recent years. Its last two attempts to pump additional liquidity into the financial system deemed only symbolic with no tangible effects. The Fed's capacity has been especially hampered by the ability of commercial banks to practice what is known as securitization.
An attempt to convert the otherwise illiquid assets, such as loans, into income producing liquid assets. I January 17, the Chairman of the Fed said "securitization of mortgages although 'basically positive', has "played a role in the still-unfolding mortgage and credit crisis" because it "makes the mortgage market 'less dependent' on bank deposits as a source of funds with which to make loans"
Such practice, in the meantime, has enabled the commercial banks to take these securitized loans off their balance sheetmaking it less illustrative of their financial strengths or weaknesses. As you know, the Federal Funds market is the main, and most readily-available, source of liquidity for the commercial banks and the main channel through which the Fed can regulate the reserves of commercial banks.
Under the condition of uncertainty created by securitization and off-balance-sheet practices, commercial banks no longer trust one another and have less desire inject their excess reserves into Federal Funds market, making it more difficult for commercial banks to acquire reserves if a need arises.
Therefore, the best source of liquidity for commercial banks has been cut off by reluctance of commercial banks to make their excess reserve available to other commercial banks. In addition, pressure from regulators has forced them to lift their lending standards creating credit crunch.
Through securitization, the commercial banks, especially the giant ones, have created this illusionary money creating, highly comlicated, scheme, engaging in non traditional high risk activities. As the bottom is falling and the so called bubble is bursting, they are all feeling chocked off.
4. Technically speaking I doubt that the US economy will plunge into a recession any time soon. Negative growth rate for the US economy is a remote possibility. However, the prolong slowdown may have the same, or even worse effects, than another soft short-lived recession. According to the WSJ published last week, most economic forecasters believe that the US economy will grow at meager rate of 2.2%, in 2008 with worsening unemployment, and inflation rates.
5. The US national debt currently stands at $9.2 Trillion, more than the entire GDP of most countries in the world. However, compared to the size of US economy, it is almost 66% of US Gross Domestic Product, GDP. When it comes to the ratio of national debt to GDP, the US is not at the top of the list.
There are many other countries with higher ratio of national debt to GDP. The US economy, as you mentioned, is debt-driven which means it is spending driven. Consumers borrow money to spend especially on big-ticket items, so called luxury items. US government, similarly, has been operating on deficit for many decades with the exception of 1998-2000 with a slight budget surplus.
6. The last banking crisis in the United States happened in late 70s and early 80s, many years in the making. The main reasons; first the savings and loan banks were cut off guard by the sudden surge in the interest rate, to double digit at some point. With their assets mostly tied to fixed interest long term loans, they started to lose money. Consequently, many of them went bankrupt after years of struggling. Second, the so called regulatory forbearance and the swing-under-the-rug attitudes of the regulators which allowed the ailing banks to continue their business for years until their problems grow deeper and deeper.
I don't believe something like that will happen this time namely for two reasons: the increasing public awareness of bank operation and the increased ability of the investors to understand and to tolerate risk, and the lessons bank regulators have learned from that bitter costly experience. In addition, combining their ingenuity with progressive information technology, financial institutions in general and commercial banks in particular, have been very successful in creating innovative risk-sharing products and digging into regulatory grounds to find loopholes.
Finally, from the style of your writing and your in depth understanding of economic concepts, I can surmise that you are a trained economist. If so, good for me, it makes me proud. If not, shame on me to see a non-economist knows my profession better than me. Please keep writing.