[related materials: A recent talk on the state of the economy (7/01); The Three Bears Redux! (3/00); An Old Talk about Current Events (3/99)]
(The below is based on a talk I gave to the Lynwood (California) Rotary Club, on February 17, 2000.)
The Goldilocks Economy and the Three Bears
This is the current description of the US economy -- in which everything is "just right"
A. booming stock market, which until recently was based on rising profitability.
Profitability rose steeply until 1998, and has showed some hesitation.
However, it's best not to focus too much on financial matters like the stock market. We need to look at the conditions that average folks face.
B. low inflation.
Went from 6.6% and rising in 1990à 2.7% and stable in 1999, except for oil prices. This is a big surprise, given C and D.
C. fast growth of real GDP.
Went from 1.7% and falling in 1990à 4.3% and rising in 1999. This is despite the fact that the Federal Reserve has been raising interest rates steadily during the last 6 months.
D. low unemployment.
Went from 6.6% and rising in 1990à 4.2% and falling in 1999. This is what worries the Fed these days. They fear that this will spawn inflation.
E. budget surplus -- lowering the government debt.
US federal Deficit of $221 billion in 1990à surplus of $124 billion in 1999. This is allowing the US government to "pay down" the government debt.
2. How we got there.
A. Goldilocks destroyed 1 chair, spoiled 2 bowls of oatmeal, and messed up 2 beds before she got the right chair, the right oatmeal, and the right bed.
B. Similarly, the US economy has been through big changes, which set the stage for the "Goldilocks" decade.
1. "Shake Out" of the early 1980s, the painful war against inflation.
10 percent unemployment for 2 years, wiping out of the old "industrial heartland," its replacement by the "rust belt."
2. increased international and domestic competition.
This is part of the process of globalization, but also the break-up of old government-sponsored monopolies in transportation (airlines, trucking) and anti-trust (AT&T).
This is a long-term trend that intensified under Reagan.
4. benefits of stagnation in Japan, East Asia, Brazil, Latin America in terms of fighting inflation here.
The fall of these economies in 1997 and afterwards showered the US economy with cheap imports.
5. this also drove funds to the US, boosting financial markets and the value of the dollar.
Fearing disaster abroad, the rising demand for US stocks and bonds meant an increase in the demand for dollars, which drove up the exchange value of the dollar relative to other currencies.
6. the high dollar means that there's a lid on inflation because of increased import competition and exports.
If the dollar rises, we are able to purchase more foreign goods (imports) with our dollars. On the other hand, their currencies can't buy as many dollars and thus can't buy as many of our exports. This limits US businesses' ability to raise prices.
3. The Three Bears.
The "Goldilocks economy" is literally living on borrowed money. The longer the situation persists, the more serious problems will be. The Three Bears are coming -- but we don't know when they will come. Their coming could cause a stock-market slump -- or be encouraged by one.
Note that we're not concerned with the government's indebtedness anymore. This is not only because the government is now running a surplus. It's also because the US federal government's debt has almost no chance of going bankrupt. (This is because of the strength of the US government, the fact that the vast majority of US government debt is to its own citizens, and the fact that the ratio of government debt to the US gross domestic product is relatively low compared to the 1950s and 1960s.)
A. Poppa Bear:
The high dollar encouraged the rise in the US balance of trade deficit. US external credit market debt became positive in the 1980s and rose to 22 percent of GDP in 1999.
The US is now a major net debtor to the rest of the world. From Doug Henwoods' Left Business Observer (at http://www.panix.com/~dhenwood/USForDebt.html) :
The outstanding debt tends to feed on itself: the US is paying more and more interest to the rest of the world, which encourages further indebtedness to pay for it.
The accumulation of debt can't happen forever, however. It's true that the US can print dollars to pay its debt and it will be accepted by other countries (unlike all other countries) since the US dollar is used as the world currency (almost as good as gold). But that threatens to undermine the US ability to do so in the future. So the Fed doesn't want to go hog-wild printing dollars to pay US debts, especially given its domestic inflation fears. They fear that the dollar will lose its exalted status, to replaced by the Euro or the Yen or some complicated situation that's hard to understand.
It is likely that either (1) the dollar will fall drastically, causing a sudden rise in import prices and thus inflation; or (2) the Fed will raise interest rates more to keep the dollar from falling, encouraging a recession. Most likely is a combination, which involves more moderate inflation and recession (stagflation).
B. Momma Bear:
The flow of credit into the US has helped finance the rise in consumer credit, as did the US government's surplus.
During 1999, American households have gone on spending like there was no tomorrow; they are saving less than ever before. Consumer confidence is at record highs and as a result, consumption is up by 5% or more a year. Real disposable incomes cannot keep pace. Despite low unemployment, average real wages (after taking into account inflation) are growing less fast than household spending. In other words, Americans are living beyond their means.
Consumers, and are getting deeper & deeper in debt. Rich folks are taking the currently high stock prices as permanent; The value of stocks and shares held by American households compared to their total income rose from
3.5 times in 1995 to 3.8 times in 1999. On the other hand, poorer folks often need to borrow to keep up with living expenses and the new "toys" our economy pushes us to buy. Bankruptcy is up. From the Federal Reserve Bank of Cleveland (at http://www.clev.frb.org/research/Et99/1199/index.htm):
One sign: margin debt is up to 1.4% of market value of publicly-traded companies, the highest under current rules (i.e., since 1974) (LA Times, Feb. 15, 2000). This is debt to pay for stock purchases, using the stock itself as collateral. Margin debt is one of the reasons why the US economy was hurt by the stock market crash of 1929. From the Financial Markets Center (at http://www.fmcenter.org/):
Either inflation or recession -- or stock-market crash -- is likely to encourage a sudden cut-back in spending, especially as bankruptcy becomes more of a threat. Bankruptcy laws have become stricter (at the insistence of MasterCard, et al).
This sudden fall in consumption is likely to make the recession severe. Outstanding debt makes it hard for the Fed to use low interest rates to stimulate the consumers to spend. It hurts the housing industry, since a major source of demand for construction is consumers.
C. Baby Bear:
Businesses do not have the same debt problem as consumers, but they have recently been getting deeper into debt. Buying up their own stocks, partly because it makes executive stock options more lucrative. With profits stopping their steep rise, businesses are more and more financing investment by borrowing. Corporate credit market debt started rising as a percentage of GDP in 1994 and has risen pretty steeply during the last two years, in 1999 getting to 45% of GDP beyond its previous peak (43% in 1990).
However, once the recession starts, this debt can become a serious problem, discouraging and then blocking further investment in plant and equipment. Unused factories and indebtedness make it hard for the Fed to stimulate private investment using low interest rates.
The following chart (from Wynne Godley at http://www.levy.org/) shows net debt as a percent of private disposable income:
Thanks to Doug Henwood and Michael Roberts for some of the statistics quoted above.
Department of Economics, Loyola Marymount University
7900 Loyola Blvd., Los Angeles, CA 90045-8410
phone: 310/338-2948; FAX: 310/338-1950 (off) or 310/202-0640 (hm.)
A recent talk that I gave on the state of the economy (7/01).
A Talk about Current Events (3/99)
The Three Bears Redux! (3/00)