After the Recession: What then?
We are in real trouble. Easy credit from foreign central banks is reaching its limit. Easy credit inside the U.S. is already a fantasy. The dollar is in crisis. Debt is rapidly becoming the name of the game, at least for us. As the dollar falls, in real terms, prices and unemployment are rising. Wages in the U.S. are stagnant.
Weekly we hear of one extraordinary effort after another to rescue us from the quicksand into which we seem to be sinking. If it is not the Fed girding its loins for another loan, then it is the G-7 examining options ranging from tighter regulations to use of public funds. Everyone is worried. Will the dominoes fall?
The G7 — the United States, Canada, Britain, France, Germany, Italy and Japan — stopped short of declaring that the U.S. economy was heading for a recession and steered clear of recommending the use of public funds to bail out troubled markets, an idea widely discussed before the meeting
Nouriel Roubini predicts that the coming recession will be a U, not an easy recovery. Calculated Risk predicts it will be a W, a double dip recession. Others see the traditional V.
I suggest we may be in for something worse. No letter the alphabet quite captures it. The only image that comes to mind is that of a slinky sliding down stairs, each deeper fall accompanied by a short rise.
What we have to ask ourselves is: What is the engine that will pull us out?
The Fed cannot do it alone; neither can the G-7. They may be able to plug the leaks, but only real business activity can do the trick. Neither Nouriel nor Calculated Risk addresses this problem.
Aside from whatever the Fed can do, we have to look at some of the factors that may reverse our fall. First, we have to accept that much of our supposed wealth creation was in fact a mirage, built on sand–or rather corruption and greed. The Fed can break the fall; central banks may continue to support us, now conditionally, I suspect. Breaking or supporting is not enough. Reversal is important.
Ultimately, the wealth of a nation depends its trade. In looking for our engine of growth, we have to look at elements that may help us. Unfortunately, our trade deficit, despite oil imports slowing, continues to increase.
Will falling oil prices pull us out? How far down must they go?
Sadly, the price of oil shows no sign of falling.
While January 2008 production has edged out the old high of May 2005, global demand is still strong. In terms of production, we seem to be on a bumpy plateau. If global growth is to continue, then production must steadily increase. To date, no producer has stepped forward to assure us that we will once again see oil at $40/barrel…or even $60. Other energy sources may be in the pipeline; but none will arrive soon enough to drive the price of energy low enough to pull us out of a recession.
What about a rising yuan? Will that make us more competitive?
We have frequently complained that the pegged yuan puts our companies at a disadvantage.
In four years the yuan has gone from 8.7 in 2004 to 7.006 in 2008: An appreciation of 15%. Allowing the yuan to float more freely has eased inflation in China. At the same time, China has raised interest rates; still, FDI has increased. But, because China has become so dependent upon its export machine, 58% of which is from foreign nationals in the China, both the rising yuan and rising interest rates are hurting exporters, who already are beginning to look elsewhere. As the Los Angeles Times notes in its lead line concerning China:
Profits are down for firms that pay for labor and raw materials in yuan but sell their products for dollars. Some companies are moving a few operations to Vietnam
The article continues:
In the past, foreign firms could cover increasing costs by squeezing their Chinese suppliers. But with the rise in the yuan and other costs, Sakkis says, that’s tough to do today. “The rules of the game have changed.”
The American Chamber of Commerce in Shanghai said 17% of companies surveyed recently planned to move some operations out of China. The study, by the consulting firm Booz Allen Hamilton, cited the appreciation of the yuan as a primary factor.
Recent reports indicate that thousands of factories in southeast Guangdong province, many of them working for U.S. businesses, have closed or moved elsewhere. Meanwhile, some Chinese businesses are refusing payments in dollars; others are breaking contracts saying they can’t meet the terms because of the high yuan.
Vietnam has Asia’s second-fastest-growing economy after China, with a large supply of cheap labor and favorable government policies reminiscent of China’s earlier days.
If Walmart’s suppliers stay in China this means higher prices for us. On the other hand, if Vietnam—or Colombia—becomes an option—then prices may stabilize, but the trade deficit will not fall significantly. It may shift to other undeveloped countries.
We have to ask: What is it that we can trade? In order to compete globally, we must have something to offer the rest of the world, something to trade.
The latest surge in the trade deficit was a result of computers, pharmaceuticals, and foreign cars. Slowly but surely we have less and less to trade in terms of finished goods. Agriculture is not enough.
Can we look to some dimension of our service sector for help?
In 2004, the IMF argued that the U.S. indeed had something to trade: Financial and business services—American know-how. In that argument, the IMF acknowledged that there were problems in the U.S. labor market:
The McKinsey report indicated that more than 69 percent of workers who lost jobs due to imports in the United States between 1979 and 1999 were re-employed (this is based on U.S. Bureau of Labor Statistics data). Of course, this means that 31 per cent were not re-employed, highlighting that there may be some rigidities in the labor market.
However, the IMF maintained that, as of 2004, the U.S. was the recipient of substantial global outsourcing in terms of services. In short, from one point of view, the U.S. had a substantial trade balance in terms of some kinds of services. These more than compensated for the fall in material goods. The IMF define these services as
To set the record straight, we look at the trade data in two categories of services that have been most intensely reported: computer and information services and other business services. In value terms, other business services (which we will refer to as just business services) are by far the larger of the two categories.
In terms of “business services,” the IMF said that the U.S. was the largest exporter. Or, to put the matter another way, the U.S., was the biggest insourcer or recipient of global outsourcing. In short, the U.S. had become a successful service society, especially in the area of business and financial acumen, despite its increasing material trade deficit.
As one writer in the National Bureau of Economic Research so aptly wrote:
First, consider the amount of ‘insourcing’, that is, the value of business services exported by a country like the US. Clearly, this is considerable – think of all the high-priced business consultants and lawyers in rich countries offering their services to the rest of the world.
Without being too ironic, I think we can safely assert that many of “business consultants” have been a bit too innovative of late. All of them—Bear Stearns, Merrill Lynch, CitiGroup, et al—were our great money makers: What we had to trade. It made some people very rich; those in the middle and at the bottom it left behind. But, as I said earlier, much of that wealth creation was a mirage, built on quicksand. Easy come; easy go.
We may fix that particular engine. First, we will rescue it (bail it out); then we must properly regulate and oversee it. But even if that service industry functions properly, it will never again be that marvelous wealth creator we thought it to be. Its accoutrements will be a bit more modest.
Which leaves us with again with the real question: Where or what is the engine that will pull us out of recession and once again into the light? This time, will we design and build an engine that profits all of us?
Frankly, I think we are going to be asking that question for quite a while. Meanwhile, prepare to watch the slinky purr its way to the bottom step.