Business Page – November 28, 2004

Four more years for George Bush - the prospects

Concluding Part 11

Introduction

Last week's column considered the context within which the re-elected Bush Administration would be carrying out its economic policies for the next four years and predicted that the economic policies would largely mirror the socially conservative policies which his base had voted for. As 2005 approaches, the world will find it hard to recall a period of sustained growth being witnessed currently. The World Economic Outlook published by IMF predicts that economic growth will have steamed along at 5% in 2004 and predicts a growth of 4.3% in 2005.

Things have never been so rosy but then to justify their existence economists always start asking what can go wrong and see in a drizzle torrential rain and in a tree a forest. Acting under the adage that nothing stays up forever, they start discussing not when there will be a landing but whether it will be soft or hard.

China - the Imperial Economic Power

The growth has been driven not by the USA, the world's largest economy but by China, the second largest and one only has to look at the staggering statistics on the Chinese economy included in Dr Clive Thomas' article in last week's Sunday Stabroek to appreciate its pre-eminent role in the world economy. In fact it was in recognition of the role and power of China's economy that it was invited to the recent meeting of the G7 group of rich countries in October last. Any slowdown in the growth rate of the China could impact on the rest of the world which has benefited from that country's huge import appetite and the comparatively lower prices of its exports helped by its pegged exchange rate.

Oil remains one of the risks to the US economy and President Bush who hails from the oil state of Texas will be promoting further exploration efforts by the oil companies encouraged by substantial tax breaks and other concessions. He knows as well that America's strategic reserves are high by any standards and that despite the oil hitting the US$50 mark for the first time ever, in real terms that is well below the historical peak. He must be hoping that with the prospects for a fresh initiative for Middle East peace and calm in Nigeria, oil prices will fall. While that will be a good thing for the world economy generally, it might have one undesirable effect - the American motorist will no longer consider it necessary to consume less petrol and the exploration efforts may be considered less urgent.

The deficit and the Guyana dollar

Spurred by tax cuts and cheap credit the American consumer spending has surged. As Senator Kerry kept reminding the voters, this is the first time in 70 years that there has been a net loss of jobs during an administration, and the rebound in the economy since 2001 has failed to prevent the weakest job recovery for half a century. While real wages grew by a mere 3%, consumer spending surged by 10% spurred by tax cuts and negative interest rates.

The obvious effect of relatively lower income and higher spending means that savings by the US household is close to rock bottom or less than 1% of disposable income compared with a historical average of 8%. The paradox is that increased savings would reduce spending on which growth is sustained. What makes reduced spending more likely is that increased interest rates are almost bound to rise in response to the budget deficit which is alarming everyone but President Bush and his team who still believe that they can borrow their way out of the hole.

This borrowing has relevance to us in Guyana as it directly impacts on the exchange rate of the US dollar to which the Guyana dollar is tied. Despite the substantial fall in the rate of exchange of the US dollar against the Euro over the past two years, many analysts believe that the dollar will fall even further and there has even been talk of something of an unlikely crash of the dollar. There may be some good news for us in a further decline of the dollar as our sugar receipts would rise but there are downsides and it would be helpful if our central bank would say something about it.

Exorbitant privilege

For America, a further gradual fall would not be a bad thing since with exports cheaper and imports more expensive the trade imbalance would narrow. The situation could alter dramatically if the drop is deeper and steeper as there may be a run on the dollar as investors demand higher returns on their investments in US government paper to compensate for the increased risk. The silver lining for the American planners is that foreign investors have too much of a stake in preventing any serious threat to the US dollar. As President Charles De Gaulle of France once famously said, America has the "exorbitant privilege of being able to repay their debts in their own currency" - both strange and unique.

How exorbitant is seen in the proportion, which America consumes, of the excess saving generated by the entire world. For that proportion to exceed, countries would then be investing in America at the expense of their own countries - an unlikely scenario. Mr Alan Greenspan, the FED's Chairman, came close to admitting this at a recent conference of international bankers when he said that foreign investors who are financing America's huge deficit would eventually resist lending more to the US. To the extent that they continue to do so it will be at a price and in lending that price is interest.

As noted last week, Mr Greenspan has tied his immense reputation to Bush's policies he must now surely be entertaining some doubts about some of those policies. Mr Bush's tax cuts rather than the Iraq war is the principal cause of the budget deficit but as Mr Bush said in his post-election press conference he earned capital in the campaign and he intends to spend it. Part of that capital it seems safe to assume would be support for even deeper and more permanent tax cuts and other handouts financed by further budget deficit.

All other things being equal, Mr Greenspan might have liked to keep interest rates at their current levels for just a bit longer to avoid any overheating in the economy and to give some help to the job market. But with the deficit plans of his President, Mr Greenspan appears to have no choice in increasing rates by perhaps ¼% to deal with the larger problem.

Key issues

But Mr Bush also has to deal with some other important economic matters among which are Social Security and reform of the tax code. Both are major headaches which normally require resources, will and capital to fix. As the President said without challenge he certainly has the capital and probably the will but it is always better to fix tax and other resource problems when there are resources to play with. With the deficit of 4% of GDP the resources are not there for any quid pro quo.

Social Security is in trouble because of the impending retirement age of the post-WWII generation. As the President said on the campaign trail, he would like to see individuals making decisions about their pensions by allowing individual accounts. The problem is that this will cost money, at least in the short term as more money will then come into the system while in keeping with his promise that no current worker would lose benefits, the expenditure will remain the same. Enter the rising deficit again.

The trouble with problems of this nature is that they are almost impossible to fix without a complete overhaul. In such an exercise, the question that should be asked is if we had to do this over from scratch, would we be doing it this way? For example how should it be structured, where should the ceiling be, what about non-payroll income, whether benefits should be linked at all and should this be to wages or inflation? Such a major overhaul has huge political implications of which the members of Congress due for re-election in 2006 would be acutely aware.

Tax Reform

This is perhaps the second major issue confronting the second term but tax reform is a long drawn out process the success of which depends on defining the policy objectives. Judging by the tax measures introduced in his first term, Mr Bush seems to think that tax reform and tax cuts mean the same thing. Even a Presidential Commission might be inconclusive while tax issues in Congress are more like sharing pork, when there is no pig to provide it.

It seems almost reckless that Mr Bush would want further tax cuts in the face of the current deficit realities but Bush has never been easily swayed by any opinion which others have of him. One of the objectives of tax reform would surely have to be to provide revenues to meet expenditure which in practice would mean raising taxes and the next question would be the most equitable and efficient method of doing so.

Conclusion

Politically at home and in policies abroad, President Bush's second term is likely to be very compatible with his easy-going style. But in respect of the economy, things will be tougher. The world can no longer do anything about China's economic dominance which is why no one bothers about such esoteric issues as its human rights record or its democratic credentials. America will continue to depend, at whatever interest rate, on the sometimes reluctant investment from abroad to finance its yawning budget deficit.

It is likely that the benign neglect of the Caribbean which characterized the first four years will be repeated in the next four. Those countries with their exchange rate tied to the US dollar should be concerned about further falls in that currency and what if anything they can do to minimize its effect.

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