Can the U.S. Avoid European Contagion?
We might have to wait until after election day to find out.
12:00 AM, May 8, 2010 • By IRWIN M. STELZER
We are all Greeks now. Or so it would seem if we are guided by the gyrations of share prices. Or if we believe that today’s Greece is tomorrow’s United States. After all, we are running Grecian-style deficits, our debt-to-GDP ratio is approaching the magic 90 percent mark that stifles growth and makes it more difficult to bring the budget deficit under control, and the effective U.S. tax rate on new corporate investment is estimated by economists Duanjie Chen and Jack Mintz of the University of Calgary in Canada to be almost twice an 80-nation average. With no room to raise taxes, and no political will to cut outlays, it is not unreasonable to worry that America might decide to print money to pay off its creditors, triggering inflation. At a minimum, the Greek tragedy has focused attention on America’s river of red ink, even though the parallels are far from exact.
Worse still, analysts have begun to explore the extent of U.S. exposure to Europe’s problems. The Bank for International Settlements says American banks hold more than $1 trillion in European debt, and J.P. Morgan’s economists estimate that the eurozone accounts for 14 percent of U.S. exports. The question now, and one that can’t be answered until the fog lifts over Athens and Brussels, and we have a better grasp on the eurozone’s policy response to its problems, is whether what is going on in Europe will roll out across the world just as the seemingly tiny problem of sub-prime mortgages engulfed the world economy.
The feeling around Wall Street is that the European Central Bank is being too slow to follow the UK and the U.S. policy of quantitative easing, that the eurocracy is unable to respond quickly to a crisis, and that therefore the danger of contagion, as it is called, is very real, with even the U.S.’s stronger economy at risk of infection. My own view is that we are having a crisis of confidence, which will ease as the reality of the recovery trumps the fear of Greeks bearing dicey IOUs.
Pity that this new nervousness about Europe, to which we can add concern that the Chinese regime is engineering an economic slowdown to head off the bursting of a credit bubble, is taking some of the shine off the recovery now clearly underway in the U.S. The jobs situation has turned around. Last month some 290,000 new jobs were created, about 230,000 of them in the private sector. The job creation data for February and March were re-estimated: The initial report that 148,000 jobs were created in those months has been upgraded to 269,000. The improved job market has attracted an additional 805,000 people into the labor market, which explains the uptick in the unemployment rate from 9.7 percent in March to 9.9 percent in April. That is typical of an economic recovery.
President Obama rushed to the television cameras to announce these gains, as always pointing out that “there is more work [read: 'spending'] to be done.” Since some 17.1 percent of all workers are either looking for jobs or too discouraged to continue doing so, he is in the nice position of taking credit for the progress, while leaving the door open to further stimulus measures.
The jobs market, of course, reflects what is going on in the economy, which seems to be in the midst of a broad-ranging recovery, albeit in some instances from a very low base. The Institute of Supply Management reports sharp increases in manufacturing output and new orders, and public sector outlays drove the construction index up a bit -- good news for a troubled sector, bad news for taxpayers who will have to foot the bill for many projects that don’t add very much to the nation’s wealth.
The auto industry is seeing sales pick up, with Ford leading the way after having refused government handouts. But sales have not picked up enough to head off the likely return of discounts and special deals this summer. The auto recovery is rolling out into other industries, most obviously makers of parts such as emissions control devices. Don’t celebrate quite yet: Chrysler is still losing money, and GM has yet to repay $50 billion of the funds received from the government last year. Toyota has its much-publicized quality and safety problems. Still, the outlook is infinitely better than it has been for years, which is good news for media companies that have sorely missed the heavy advertising programs of the car makers.
Auto showrooms are not the only places enjoying greater consumer traffic. Consumers are snapping up appliances, the iPad’s sales of one million units being the most publicized. A survey by the National Association of Business Economics found that 57 percent of respondents are experiencing an increase in demand, while only 6 percent say demand is falling.
There is more good news from companies reporting profits increases and shops and malls experiencing an increase in traffic. Enough, in fact, to make a one-handed economist smile happily. Unfortunately, there are few such, so there is the inevitable “on the other hand.” The housing market has been benefiting from tax breaks for new home buyers and support of the mortgage market by the Federal Reserve Board and Freddie Mac and Fannie Mae, aptly called GSEs, government supported enterprises. The tax break has expired, the Fed is reducing its support of the mortgage market, and Freddie Mac, the nation’s second-largest provider of residential mortgage funds, is asking congress for an additional $10.6 billion in federal aid after losing $6.7 billion in the first quarter of this year. Just how much all of this will affect the very tentative recovery in the housing market only a braver man than this writer would predict.
Then there are the problems created by a wildly expansive fiscal policy. The current recovery would be threatened if interest rates were to rise significantly. That is not outside the realm of possibility, given our ongoing deficits, investors’ worries about sovereign debt, and the rating agencies’ warnings that the U.S. had better get its house in order or face a downgrade.
Add to this the virtual certainty that when the president’s debt reduction commission reports in December -- not coincidentally after the November elections -- it will recommend tax increases that will be piled on top of the added costs small and medium-size businesses face from the health care “reform.” Not a recipe for rapid growth.
Still, economists at Goldman Sachs are predicting that the current 3 percent growth rate, after falling to 1.5 percent in the second half of this year, will re-accelerate to the 2.5 -3.5 percent range in 2011, as “Fed policy remains easy and the multiplier effects from earlier fiscal policies are still rippling through the economy.” Which doesn’t speak too well for prospects after the Fed tightens and Obama is forced to reduce deficit spending. But that’s for later. Now, spring is sprung, the economy is on the move, and Greece remains far away.
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