State of the Economy

With the rest of the world sliding into an economic depression, the U.S. economy keeps barreling along as if nothing’s wrong. Why, when other nations are struggling with bank failures, high unemployment, devalued currencies, depressed commodity prices, and soaring consumer prices, is our economy doing fine? Here are some reasons:

Low commodity prices. Most U.S. companies don’t produce or extract commodities anymore (i.e., oil, minerals, ores, food products, etc.)–and the ones that do can get special tax waivers or subsidies from the U.S. government to keep them in business when prices go down. Most U.S. companies benefit when commodity prices drop, because they have to purchase raw materials to refine or manufacture their products. Last year, the Asian collapse led to less demand for basic commodities (especially oil) in Asia. That meant a surplus of these items on the world market, which drove commodity prices down to historic lows. And February’s currency slide in Brazil caused a panic in the coffee and sugar markets; as the Brazilian real became less valuable, there were fears that Brazil would try to sell a lot of its coffee and sugar at lower prices on the world market in order to get more hard currency to pay off its skyrocketing national debt. U.S. importers are perfectly happy to pay less for basic goods, because it means they can make more money on the finished products they sell. Food importers thrive, especially since very little of their price savings will be passed on to the consumer. On the other hand, low oil and gas prices have meant average folks here in the U.S. can spend less money on heating bills and at the gas pump and more money at the shopping mall.

Low interest rates. Because the bottom 90% of Americans make an average salary of only $34,000 per year, most Americans have to borrow money to buy the things they want: cars, houses, new clothes, vacations, etc. The U.S. government and the banking industry have made this easier in two ways: 1) through a series of laws liberalizing the banking industry and credit (which has expanded the number of people who qualify for loans and credit cards and increased the number and type of loans that banks can offer), and 2) by keeping interest rates extremely low. This is what fuels the Federal Reserve’s (and Wall Street’s) obsessive fear of high interest rates. If interest rates go up, credit becomes tight–which means no one can afford to borrow money to spend. This could send consumer spending into a tailspin, U.S. companies would suffer from lagging sales, workers would be laid off, and a recession would ensue. So it’s very important to keep interest rates low enough that middle and upper-middle class Americans feel like they’re getting a good deal when they buy a new car, refinance their mortgages, go shopping at the mall, or take out a home equity loan. Right now, inflation is at its lowest rate since 1950, and interest rates are lower than they’ve been for several decades.

Easy credit. Not only can Americans get cheap loans, but they can go deeper into hock in more ways than they used to. And credit is finally percolating down to the poorest of us, too (although the poor can’t get the extremely low interest rates that middle and upper-middle class Americans can). Yet credit is enough of a novelty for poor folks and their need is such that they are beginning to borrow quite a bit. It’s also difficult to say no to credit cards or high-interest mortgages that hook you in with short-term low credit that automatically becomes high-interest after only a few months …. or one late payment (whichever comes first). While many of the people borrowing money to spend right now can easily afford it, many can’t.

High corporate spending. Yes, companies can go into debt to make purchases, too. One of the main ways they do this is by issuing corporate bonds. After the collapse of the Russian ruble last year, many U.S. investors took their money out of foreign bonds and risky U.S. stocks and went in search of safer investments. Much of that money flowed into the domestic bond markets, and a big chunk of it went into corporate bonds. Combined with a fall in prices for computers and electronics because of lower-priced Asian imports, this infusion of cash has allowed corporate America to buy more technology for the workplace; capital expenditures, which were flat in 1997, soared by 21% last year. Companies have also been able to hire more workers, even from among the ranks of the “chronically unemployed,” adding more people to the pool of consumers who can buy products. Official unemployment is at a very low 4.6%. With more workers and more cash, U.S. companies have also expanded production.

All of these factors are keeping our economy going right now, but there are several clouds on the horizon. For one thing, many companies are laying out a lot of cash to buy computers, phones, copiers, fax machines, software, etc. that are Year 2000 compliant, rather than wasting the time to try and fix what they have, or risk a potential liability problem if something fails eight months from now. Once this issue disappears, the market for electronics will shrink to a more reasonable level (and high-tech businesses will feel the pinch).

Interest rates simply can’t remain this low forever. Collecting interest is how banks, financial companies, and risk-averse investors make money; eventually, banks and finance companies will work out a way to bring consumer interest rates up.

In a world where the U.S. is the consumer of last resort, Americans may be able to soak up a lot of the world’s surplus goods–at least in the short term. But the world (and the U.S. in particular) can hardly afford to continue expanding production forever. Americans are already becoming tapped out in what they can afford to spend. Last year, the U.S. had a negative savings rate for the first time since 1933–meaning Americans spent more than they saved. This is not a minor blip on the radar screen, it’s the continuation of a long trend of Americans saving less and less each year. At some point, either a very large number of us will go bankrupt all at once (over 1 million Americans declared personal bankruptcy in 1997, and a larger number in 1998), or–more likely–most Americans will drastically cut back in their spending to pay off their debts–the very thing that the Federal Reserve, Wall Street, and corporate America fear the most.

So, while I hate to sound like I’m predicting the next big crash, I have to say that, although things are “looking good” now, the underpinnings are very weak. With a shrinking government safety net, the few poor folks who’ve found decent-paying jobs and the many middle class folks who are heavily in debt will be the ones to suffer most if a recession hits.