October 1, 2001
The “zero tolerance” king has been playing a blinder. Even Democrats in New York would tick Rudi Giuliani’s name on the ballot if he were to run for a third time. However, he is debarred constitutionally. But his creed of “zero tolerance” has yet again become the calling card of the USA. This column discussed long before September 11 the US attitude of “zero tolerance” of economic pain. Now this attitude is more evident than ever.
American consumers display zero tolerance of being ripped off. While Irish punters shrug their shoulders at expensive houses, insurance and electricity charges, Americans just won’t tolerate such carry on. Equally, US managers have no tolerance of recessions and will fire employees immediately, close plants and cut back investment at the first sign of an economic slowdown. In Ireland, we try to string things along hoping for a silver lining but in the end, cutting quickly is probably the best for all concerned.
Likewise, US investors will dump stock in firms they believe cannot make it, while in Ireland we hold on to stocks such as Eircom in the expectation that its price will recover rather than realising a small paper loss at the first sign of trouble. This speed of movement and facing up to new realities defines US business practices.
In the past few weeks a new zero tolerance has emerged in the US: a zero tolerance for ideology. At the height of the boom in 2000, the twin pillars of free capital movements and free trade added to sanctions abroad against delinquent states such as Pakistan underpinned America and the US view of how the world worked. Commentators and politicians eulogised about the brave new world where only one ideology prevailed, leading to, among other things, the Boston versus Berlin debate here.
However, just when Irish politicians were set to make the Boston/Berlin debate a possible ideological backdrop to next year’s election, the Americans are now showing us that they believe ideology is a luxury that can be dispensed with when times are rough.
Today, America is using massive government spending, huge sector bailouts and aggressive cutting of interest rates to get out of an economic hole. Gone is the rhetoric of the free market, small government and reducing the national debt. Big, active government is back and the spectre of Mr Keynes, long derided by US policy makers, looms. Ironically for George W Bush, the man who was described as being further to the right than Ronald Reagan, the new ideology in the US is more Roosevelt than Reagan. The US government will spend its way out of this recession.
Abroad, the Bush administration is putting practicalities before dogma by pumping money into Pakistan — a country that was under strict US trade sanction — and has a freeze on all US foreign investment. India, America’s recent ally on the sub-continent has been given the cold shoulder to accommodate America’s new best friends in Karachi.
For Irish investors, employees and homeowners, America’s ideological musical chairs only matter insofar as the new ideology-free administration can keep the US out of recession permanently and that Irish policy makers, when faced with the first recession since the 1980s, do not paint themselves into a purist ideological cul-de-sac. So can the US avoid a long recession?
Probably not. In 2000, at the height of the boom, this column argued that the US was on a binge, fuelled by cheap credit and the willingness of the rest of the world to finance the American current account deficit.
With a trade deficit of $1 billion a day, it was clear that the US was living beyond its means. Americans were running down their savings and the bull market cheerleaders who were masquerading as impartial economists, failed to see why the reason the return to capital appeared to be rising.
History shows that productivity always rises at the peak on any cycle. Thus the US was experiencing running up against a capacity problem. The more money thrown at an economy operating at full tilt the more overvalued the stockmarket. In short the US needs a recession to clear the decks, get people saving again and reinstate some rationality into a stock market which is still priced at 30 times earnings.
If the US government now inflates the economy with the least $80 billion in spending announced last week and with permanently low interest rates, it will stave off a recession in late 2001, early 2002. The dollar will skyrocket and long-term interest rates will remain above 6 per cent. The trade deficit will get worse and America will be more reliant than ever on foreigners to finance the largesse of both its government and its consumers.
However, any recovery will be scuppered by the same capacity problems that emerged in 1999. We will see a weak, government-inspired rebound which will also cause the stock market to rally, followed by deeper recession and a slump in the market.
When the dollar ultimately drops it will have further to fall and, with the Fed probably raising rates aggressively by mid 2002, the cost of borrowing for corporate America will rise. It looks likely therefore that the US will try to engineer a brittle recovery now, avoiding a long recession in 2002 only to slump back again in 2003.
However, at least US corporations will have been given a little more time to try to recover from the excesses of the late 1990s. And, with the right policies abroad, there might be a chance that the rest of the world is in a better position to take up the slack in 2003.
Back home, can Irish politicians dispense with their new-found ideology and deal with the coming recession in a pragmatic way? Tax revenue has been slipping since the start of the year, confidence has evaporated, house prices are falling and the bubble is bursting.
If we are to avoid a recession, either people need to be encouraged to take on more debt or the government will have to. Punters are already up to their gills in debt, so it would be imprudent for individuals to take on loans.
But for the state it is a different matter. Given the searing experience of government delinquency in the 1980s, many advisers are cautioning against government borrowing next year. But this is because of an attachment to a mantra rather than hard thinking.
In the past when the government borrowed too much, interest rates rose, the exchange rate fell and ultimately inflation rose. Higher inflation wiped out any competitive gains, dragging the growth rate down. Ultimately, unemployment did not fall very much and the debt burden grew, causing the next government to raise taxes to pay the debt, causing the economy to slow further. Thus the initial flush of cash from borrowing was the ultimate “fools gold”.
Now things are totally different. We are in EMU, so nothing we do here will affect our interest or exchange rate. With no interest rate cost, government borrowing comes close to being a free lunch.
Our national debt ratio, even if it meant something in the context of EMU, is very small anyway, giving us huge latitude to borrow without any immediate fear of having to raise taxes. So running budget deficits will be no big deal and that is how we should deal with the impending recession.
America is willing to abandon mantras and ideology in the face of a crisis. We should do likewise and emulate Mr Keynes who when asked what ideology formed his view of the world, responded “The facts, the facts, my dear boy and when the facts change, I change my opinion”.