by Tion Kwa, Asia Society Bernard Schwartz Fellow
The market convulsion in Asia and Europe in the latter half of January shows the world has been deeply worried about the prospect of a recession in the United States. And while there continues to be debate over economic decoupling between the US and other economies, the verdict of Asian and European financial markets betrays no such view. The US Federal Reserve's emergency rate cut on January 22 sparked hopes that a recession in America could be avoided, prompting rallies and gains in major stock indices around the world. Overseas markets continue to see the health of the US economy as crucial to their own growth. Fingers are crossed that the Fed's aggressive cut will do the job.
Well, maybe. The trouble with monetary-policy intervention, which is expected to be followed through in upcoming Fed policy-setting meetings, is that it is unlikely to bear fruit quickly. And neither will the fiscal initiatives just agreed to by the Bush administration and Congressional leaders. Out of the $150 billion that is to be spent to fluff up the economy, $100 billion will go to individuals and families. But the bulk of recipients, who will be paid through the tax office, won't start getting payments until May, and it could take until the end of the next month before everyone's had a check in the mail. The likelihood then is that little will get "stimulated" before dog days of summer.
Meanwhile, there are already plenty of signs of consumer pullback. Over the past month, I've conducted a little informal survey. Once a week or so, I visit a couple of department stores to check the prices of a few items. At Macy's, for example, the gloves and cardigan I bought at the day-after-Christmas-sale remain at the same price. A month after the big sale, prices surprisingly are still stuck at deep discounts. It's been difficult moving out inventory. Downtown store-fronts continue to display sale signs, now starting to look a little sad. To those of us who lived through the Asian Crisis a decade ago, this is all eerily reminiscent of late-1997 and 1998 across a swath of East Asia. Indeed, that crisis also started out as a financial-market disruption that quickly evolved into an economic crisis.
For businesses sitting overseas, particularly those dependent on exports to America, there will be difficult quarters ahead. Orders for summer inventory are being evaluated and should be signed soon, if not already. They are unlikely to reflect optimistic projections in consumer appetite. And apart from seasonal clothing, inventory overhang could further dampen import demand in the US. This in turn may spark competitive price cutting among overseas manufacturers, squeezing margins.
Yet, if it turns out this way, it would still be the best possible outcome under the circumstances. There'd be a few quarters of difficulty, but also an expectation that things will pick up in the second half. Unfortunately, there is the weakness in the dollar to contend with. And going forward, the dollar can only be expected to wilt some more, the consequence among other things of easing monetary policy and fiscal pump-priming. To judge by one estimate, the stimulus package might add at least $100 billion to the deficit in the current fiscal year.
A weak dollar has ramifications in many areas, but perhaps the most important is in the price of oil. Although oil has retreated from the $100 level, a weak dollar will continue to put a floor under prices. Thus, after spending through their windfall from Washington, consumers will return to the reality of high pump prices and the pass-on effect of dearer food, again crimping consumption expenditure.
In the meantime, oil prices threaten to undergo a change in the way its value is perceived. Until recently, prices have been "high" but not "expensive"—meaning overvalued. This is a crucial distinction, because high prices have been related to robust economic expansion. A part of the price was supported by the demand from productive growth, a virtuous connection. But as consumption again slows after a brief bump up in the summer, growth moderates and the dollar continues to slide, the weighting between "high" and "expensive" moves closer towards the latter. Price becomes more reflective of the dollar's declining worth. And expensive, overvalued oil in turn will further dampen consumption and growth, setting up more trouble down the line.
Now, things might be different if the stimulus package had been constructed differently. But it's always a bad sign when Republicans and Democrats can manage to quickly agree on spending in an orgy of congratulatory back slapping. When everyone is so willing to compromise, the result is usually tepid. Predictably, then, the mostly Keynesian prescription will do little to stimulate productive elements in the economy, ones that more directly sustain and create jobs. After all, two-thirds of the expenditure will go towards subsidizing shopping sprees. If you throw money at the economy, sure it will react: The wheels of the economy get a few extra spins; but no more than that. As for measures aimed at businesses, they will help this year. But only by borrowing some spending from future years. (At least when the Japanese went on their building binge during the 1990s, even roads in sparsely populated area got some use over subsequent years. In comparison, you might be tempted to excuse the Japanese for their own pump-priming. Almost.)
Had Washington's stimulus package made the administration's previous tax cut permanent or snipped the capital gains tax, it could have prompted new investments better positioned to turn the lower dollar into an opportunity for improved exports. But as it stands, the plan can only said to be deferring problems to the future—on the hope that a new engine of growth will eventually emerge. We just can't figure out what it might be right now.
For those who live on the other side of the Pacific and Atlantic, prudence should require preparation for a prolonged downturn in America that will seep its influence abroad. Of course, things would be different if the world truly had decoupled from the United States. But even the financial markets are skeptical.
Tion Kwa is an editorial writer and op-ed writer on foreign affairs, business, and economics at the Straits Times in Singapore. He is a Bernard Schwartz Fellow based at the Asia Society's Washington Center, where his work focuses on trade issues between the US and Asia as well as regional security.