Rise in Rates Points to Days of Reckoning
As the Republicans convene in New Orleans to sing the praises of a six-year economic expansion, sour and even somber notes are sounding elsewhere.
The Federal Reserve hiked interest rates last week in response to signals of inflation. Fed governors saw businesses holding back inventories in anticipation of price increases, so they moved to nip an inflationary spiral in the bud.
And the boost was necessary, of course, despite the pain inflicted on consumers--as mortgages and variable-rate loans get more expensive--and on businesses contemplating new investment.
But the problem may be more serious than a slight fever in an otherwise healthy economy.
The ominous thing about the interest rate hike is that it comes at a critical time. U.S. industry has only recently begun to reduce the trade deficit--which is still about $150 billion a year--but already exporters in electrical machinery, paper and chemicals are running out of spare capacity. The time has come to expand the plant, but doing so now will cost more, and yield less competitive advantage. Why did things get tight so soon?
Because U.S. industry in the 1980s has had the lowest rate of investment in plant expansion since World War II. Why? A series of discouragements: The recession of 1982 clobbered investment, and then the high dollar discouraged it further by making U.S. goods uncompetitive. Finally, the decade’s enthusiasm for restructuring has reduced productive capacity.
To be sure, U.S. industry had to respond nimbly to global change, but there is growing evidence that it, and the American economy, have simply fallen behind.
For example, U.S. industry has put only $2,600 a year of equipment behind each worker in the 1980s, compared to (who else?) Japan’s $6,500 per worker, says Business Week. That caused U.S. productivity growth--output per worker--to lag that of other countries.
A consequence of lagging productivity has been lagging wages. U.S. government statistics show average hourly wages declining in the last 10 years.
No wonder first-time home buyers--according to a new study by the National Assn. of Realtors--have trouble making a down payment on a house. Last week’s interest hike adds to their troubles.
So clearly a slow rate of industrial investment hurts everybody’s standard of living. The big question is why it is happening and what can be done about it?
The federal deficit is to blame, says economist Benjamin Friedman of Harvard, author of “Day of Reckoning,” a book on the Reagan economy. Friedman is a Democrat and has a political bias.
Concerned About Debt
But there’s nonpolitical logic in his analysis that deficits caused interest rates to be higher than they might have been. As a result, financial markets offered corporate managers a higher payoff on company cash than investments in the company’s business.
The consequence, he says, will be a limit on economic growth (and U.S. living standards) because investments to produce the growth weren’t made in the 1980s and, furthermore, because the government has borrowed billions from foreigners to finance the deficits.
Economists in Tokyo, who are neither Democrat nor Republican, confirm that diagnosis. “We are concerned about the accumulated debt of the United States,” says Hirohiko Okumura, chief economist of Nomura Research Institute. Okumura is referring not to one year’s deficit but to the sum of the decade’s foreign debt which has now passed $800 billion and is rising toward $1 trillion.
Does “concern” mean a threat to pull Japanese investments out of Treasury bonds? No threats needed, Okumura explains, because world money markets “adjust for risk constantly; that’s why your interest rates are so high.”
What’s to be done? Obviously, the next Administration--of whatever party--will have to eliminate the deficit. And that means a tax increase of some sort to curb foreign borrowing, and help get interest rates down. Because as long as U.S. business has to pay 10% interest, while German business pays 6% and Japanese companies less than 4%, there’ll be little to sing about in the U.S. economy.
