Monday, November 17, 2008
When it comes to the economy, the president is like a quarterback. Just as the quarterback gets most of the credit and blame for the outcome of a football game whether he deserves it or not, the president is treated similarly by the general public in evaluating the economy during his presidency. Perhaps President Clinton’s legacy, aside from trying hard for the Middle East peace and all the other past legal headlines, is going to be that he presided over the longest peacetime economic expansion that began, ironically, under President Bush Sr. in March 1991.
Is there going to be an “Internet Depression”? Or a “hard landing” with the economy experiencing contraction? Can the US Federal Reserve and Captain Greenspan steer the economy to a “soft landing”, where the economy cools enough to vent inflationary pressures but does not go into a recession? Or has the Fed tamed the business cycle altogether in this “Information Economy”?
Historical Perspective
As far back you can go in financial history, we have seen business cycles - economic ups and downs. Long ago, when the economies were agriculture-based, cycles were caused by unpredictable harvests. Then the Industrial revolutions and trading economies began to outweigh agricultural cycles, and recessions were caused by too much production, inventory buildups, flow of gold from the new territories etc. After the Great Depression, economists tried to understand the causes of business cycles, and thereby ways to avoid/dampen business cycles. One pattern seen over the past 60 years or so was that inflation and employment were inversely related. But in the last few years the unemployment rate went down to below 4 percent, yet inflation kept going down to about 2 percent with the US economy growing like an Asian Tiger (before the Asian crisis in 1997). Was this the “Brave New World” of an Information Economy?
Let’s see why the expansion has lasted so long – one of the important reasons is that in the last ‘down’ cycle of 1990, everybody shaped up - corporations deleveraged, the banking sector was cleaned up after the Savings and Loan Crisis, and consumers improved their financial health. Then there was the peace dividend from the fall of the Soviet empire, with free markets and free trade everywhere, budget surpluses leading to lower interest rates, etc., and of course investment in information technology boosting productivity.
During this expansion, in 1994 when the economy was growing a little faster than the Fed liked, Greenspan & Co. doubled the interest rates and thus engineered a softer landing in 1995 when the economy slowed down from a 4+ percent rate to about 2+ percent. This deft handling, along with some luck, extended the expansion. Just as the US economy was heating up again in 1997 and the Fed raised interest rates, the global financial crises in Asia and then in Russia and Brazil forced the Fed to loosen monetary policy and thus provide liquidity to financial markets. The US Treasury under Robert E. Rubin and the supra-national agencies like the International Monetary Fund and the World Bank provided enough liquidity to Mexico, S.E Asian countries, Russia and Brazil to avert a global economic collapse.
All this cheap money led to booming stock markets which then became underwriters of many technology companies at much earlier stages than it formerly had. Even after the Fed began to tighten in 1999 the Venture Capitalists from Sand Hill Road to Flatiron and elsewhere in the world financed not just technology companies but ‘old economy’ businesses like grocery stores, pet food stores and even personal services businesses doing things like running errands and home delivery etc.
The new economics forced the old economy to invest more in technology and keep prices lower to compete with online counterparts. This led to higher productivity, lower prices and continued economic expansion. If it is really a new economy then the business cycle is now tied more to the technology sector and not to the agriculture as it was a few centuries ago, or to industrial production or the real estate sector. Supply chain management may have led to just-in-time inventory, which would mitigate the impact of business and inventory cycles. What we may have now is the economic cycle tied to technology spending, venture capital investments and a healthy stock market that can digest early stage IPOs.
Rising oil prices in early 2000, Fed rate hikes, and saturation of consumer demand have slowed the economic boom. In the process consumers have accumulated over $4 trillion in debt. Consumers that spent “stock market wealth” on consumption will reduce spending in response to the 40 percent correction in the NASDAQ market. It is guesstimated that the $1 trillion drop in NASDAQ in 2000 versus a $4 trillion gain in 1999 will reduce consumer spending by $150. And a slowdown would lead to smaller budget surpluses and lower government spending. If all three sectors of the US economy -- consumer, business, and government -- weaken, a generalized slowdown in the US is a distinct possibility.
Global Impact
A slowdown in the US can have a significant impact on the global economy. US growth has been estimated to contribute almost 70 percent of world economic growth in this global economic cycle. The US has helped the rest of the world by absorbing their exports. In the process, the US current account deficit (CAD) has ballooned to over 4 percent of the GDP. It is nowhere close to the CAD level in Thailand and other countries at the time of their crises but is at an alarming level. That could undermine confidence in the US dollar. Asia and India, which depend on the US economy for export markets, will feel the punch. The Indian stock market went through a super-bullish phase, and has seen a significant correction over the last 12 months.
So, are we looking into an abyss? Is there to be an apocalypse now? With all the lessons learned from the Great Depression and more recently from the Japanese prolonged slowdown and the Asian, Russian and Latin American crises, I think the Fed has learned enough to prevent similar outcomes there. But will we ever see the good times of the 1990s again? Will the new President Bush face economic times similar to those faced by Papa Bush? President Clinton, you were better quarterback than many, and a damn lucky one too!
Shirish Malekar is the founder and CEO of SMYLe Technologies. Prior to this, he was a partner and portfolio manager of global investments at Strong Capital Management. Write to him at: shirish@corp.siliconindia.com.
