Federal Reserve Board Chairman Alan S. Greenspan testified to Congress on Tuesday morning that there would be no recession this year, but that the economy faces "formidable challenges" to keep economic growth and price stability going past this year.
Paul A. Volcker, Greenspan's predecessor as Fed chairman, spoke more bluntly in a speech last Sunday, saying that unless the United States reduces the government budget deficit, it is heading for "financial chaos."
What's the big worry? Things aren't so bad at the moment, after all. Unemployment is low and there's overtime work in America's factories; interest rates are moderate and mortgages are affordable.
But Greenspan and Volcker recognize that the U.S. economy is at a crossroads, and they can see dangers ahead ranging from inflation to recession. They recognize that the economy is undergoing a historic shift in emphasis, and a tug of war for resources has begun.
On the one hand, the U.S. economy is becoming more production and export-oriented, as the reduced value of the dollar in the last two years has made U.S. goods more competitive on world markets and U.S. companies have made their operations more efficient in response to global competition.
The lower dollar, also, is one reason why foreigners, especially the Japanese, are investing here at the moment--building plants, buying buildings. They realize that the lowered currency not only makes imported goods expensive for U.S. customers, but makes the highly industrialized United States a low-cost manufacturing center.
On the other hand, the economy we have known is changing profoundly. For at least two decades, it has been driven by consumer demand. An abundance of money has been available to finance housing and consumer goods.
Yes, there were people left out of the great American consumer binge, but unprecedented numbers of ordinary Americans were able to live like citizens of the old Roman Empire--sampling goods brought from all over a world that produced clothing and cars, and luxurious baubles for pampered consumers, who shopped in temperature-controlled malls.
The malls won't go away, but they will have to scramble for tenants as retail firms merge or go out of business. Consumers will still be able to borrow, of course, but there may be less money available and at higher interest rates.
Because more of the economy's productive effort will go toward making goods for foreign customers or to pay interest on America's debt to foreign lenders.
Rise in Rates
That sounds like a strange notion, until you examine the numbers put together in a paper called "The Late, Great Consumption Boom," by economist Charles Clough Jr., the chief investment strategist of Merrill Lynch. The United States now owes about $450 billion to foreign lenders, says Clough. And the interest on $450 billion is $40 billion a year.
To put that in perspective, the U.S. gross national product--the sum total of all the goods and services the economy produces--is $4 trillion. So fully 1% of everything the U.S. produces from now on will go to pay interest on foreign debt. (Note: just the interest on the debt.)
So, if you consider that the economy this year may grow between 2% and 2.5%--which is Greenspan's prediction--that means half the economy's growth will go for interest and not for an expanded supply of goods and services for Americans.
Short-term, the shifting economy could see a tussle for available resources. With the economy still strong, U.S. consumers have steady jobs and income. Their demand for goods and services, coupled with rising export demand, will strain the economy's capacity and cause rising inflation before the year is out, says economist David Levine of the Sanford C. Bernstein research firm.
And that, in turn, will bring about higher interest rates to slow domestic demand--which, of course, could throw the economy into recession.
But the trouble with the U.S. economy today, as worriers Greenspan and Volcker understand, is that a continuation of low interest rates could also lead to recession if it convinces foreign lenders that the U.S. government is pursuing an election year policy of easy credit to keep consumers happy. Foreigners would then cease to finance the deficit, and let the dollar decline, which would raise import prices, cause inflation and force the U.S. government to raise interest rates.
So a recession seems inevitable. There are worse things, Chairman Lawrence Chimerine of the WEFA economics group points out. World trade could diminish as it did in the 1930s, when nations withdrew into regional blocs, and a worldwide depression could set in.
Compared to that, the fearful passage the economy is negotiating may be reason to worry--but not to despair.