THE NEW YEAR has begun not with a quiet whimper, but with a very loud groan, emanating from Wall Street. Economists and analysts are rushing to revise their 2008 forecasts, and journalists are competing for page one placements with scary stories about evicted homeowners sleeping in the streets, and consumers filing for bankruptcy. Western singer Kris Kristofferson did not have fallen CEOs and other investment bankers in mind in mind when he sang about the man who "Once ... had a future full of money, love, and dreams, which he spent like they was goin' out of style," but it is an apt description of many shell-shocked bankers and investors.
They have reason to worry. Oil finally hit $100 per barrel, sending share prices tumbling, gold prices soaring in anticipation of renewed inflation, and developing nations deeper into poverty. Food prices continue their upward trajectory and, combined with gasoline prices that are due to break new records, are reducing consumer discretionary-spending power to a mere shadow of its former self. Latest surveys suggest that even soaring exports will not keep the U.S. manufacturing sector from slowing down, with falling sales of autos a particular drag. So desperate are dealers to clear inventory-laden lots that one has taken out a magazine ad offering 12-year financing to anyone who thinks he can afford the gasoline guzzled by one of the Rolls Royces sitting on his lot. Most important, last month the unemployment rate soared from 4.7 percent to 5 percent, with more industries losing than gaining jobs.
Whether all of this will produce a recession in 2008 remains less than certain. Alan Greenspan puts the odds at 50-50. Some economists rate the probability of a recession higher than that, others are a bit cheerier than the former Federal Reserve Board chairman. It is so difficult to peer through the blur created by the daily volatility in share prices and business sentiment that uncertainty is the order of the day.
With reason. We don't know whether the president will go through with plans being discussed at the White House to propose a fiscal stimulus in the form of more generous depreciation allowances for businesses, and perhaps even a corporate tax cut. Nor do we know whether the Fed's heightened concern about the extent and speed of the slowdown will prompt it to accelerate its rate cutting plans, inflation worries notwithstanding.
But there are some things we do know. Two forces have come together that are likely to change in a very profound way the structure of the financial services industry. The first is the need for many banks to rebuild their balance sheets by attracting equity; the second is the need for the sovereign wealth funds of oil-producing and exporting nations to put their cash to work. The result has been--and what we have seen so far is only the beginning--the purchase by these funds of important positions in Merrill Lynch, Citigroup, UBS, and other banks and investment firms. So far, the politicians have remained silent, lest they be accused of interfering with the inflow of desperately needed capital. Senator Chuck Schumer, the opponent of Dubai's acquisition of some U.S. ports, has been notably silent, lest he antagonize the Wall Street bankers who have bankrolled his campaigns.
We know, too, that as the greenback depreciates in value, foreign central banks are less and less inclined to keep stores of pictures of American presidents in their vaults, and more interested in diversifying their currency holdings. The dollar's share of central banks' holdings of foreign reserves has fallen from 66.5 percent to 63.8 percent in the past year. Equally important, oil-producing nations, which until now have accepted dollars-for-crude, and have pegged their currencies to the dollar, are finding it increasingly difficult to hold to that policy. The dollars they are getting, which they use to pay the large foreign workforces on which their work-shy citizens rely, buy less and less when remitted to the wives and families of these workers. That is causing social discontent of the sort that horrifies the ruling classes in the Arab countries. My guess is they will begin pegging their own currencies to a basket of currencies that includes the dollar, but in which the euro is importantly represented. A negative impact on U.S. influence in the region is one possible consequence.
The paradox is that just as the euro becomes more acceptable outside of euroland, it is the source of serious grumbling at home. The "high" euro, and the European Central Bank's stated intention of preventing inflation from eroding its value, is hurting exporters, and making imports from China--which has relaxed the yuan's peg to the dollar only a little--cheaper still. Italians blame domestic inflation on the euro, and pine for the return of their lire, showing just how fallible memories can be. And Nikolas Sarkozy, appalled by what he believes to be an over-valued euro, is leading a battle to give politicians a say in determining interest and exchange rates.
We know two other things. The first is that the U.S. economy will indeed slow, at least in the first half of 2008, as the credit crunch--as it is oddly called given that banks are awash in cash--unwinds. The second is that whichever one of the Democratic contenders ends up in the White House, he or she will be pledged to please not only the trade unions but a broad swathe of voter opinion by retreating from the nation's historic position in favor of free trade. Doha, if not already dead, will breathe its last, and be buried. The new president will not sign on to any new trade deals. The free flow of goods will be inhibited by increasingly protectionist measures, the free flow of capital will be threatened by increasing scrutiny of the non-transparent sovereign wealth funds, and the free flow of labor made less free by more stringent border controls. Free trade, R.I.P.
These are all small things, compared to the really big thing that we know. The American economy is an amazingly resilient and flexible machine. Remember the dot-com bust, which is cited as the model for what we are about to go through? Since that dreary period the U.S. economy has added eight million jobs. In real, inflation-adjusted terms, the value of the goods and services produced in America is about 15 percent higher than it was during the dot-com bust. And even after the precipitous drops of recent days, the leading share-price indexes are healthily up over dot-com bust levels.
If you need any further proof of the ability of the U.S. economy to survive and thrive after taking a blow, consider the speed with which output, employment, and every other indicator rose soon after the devastating attack on September 11. Or after hurricane Katrina. Or ask yourselves whether you can identify the enduring impact of these events during the Clinton years, now remembered, and not only by Hillary Clinton, as a golden age: the Mexican peso crisis, the Asian financial crisis, and what scholars now call "the crisis of confidence and legitimacy of the international monetary and financial system."
It is now fashionable to call the year just ended a year of two halves--a prosperous first half, followed by a sub-prime infected second six months. This year might just prove to be the reverse: a stormy first half, followed by gradual brightening as America's entrepreneurs find new fields to conquer.
Irwin M. Stelzer is a contributing editor to THE WEEKLY STANDARD, director of economic policy studies at the Hudson Institute, and a columnist for the Sunday Times (London).