WHOEVER has won the US election, he will be reasonably assured that he will preside over an economy that is on the mend. Last weekend I spoke to someone who knows Obama well and is a big Democratic fundraiser in California. His assessment is that Obama knows that the economy is moving in the right direction but he also knows that the next president will gain credit and this is one of the factors driving him as he would be appalled if Romney took the economic plaudits.
Whether this is a fair assessment of the president’s state of mind, it is significant that the US economy, after a few years on the ropes, is recovering. One way to look at the last four years of economic policy in the US is that a battered, bruised and very sick economy has been nursed back to health by a central bank and a government that is putting growth first and is worrying about austerity later.
To achieve this, the central bank has kept interest rates as close to zero as possible in order to ease the severe deleveraging that has gripped the US since the property/credit bubble burst in 2008/9. In tandem, where low interest rates have not worked because the people have too much debt and the banks too much bad debt, the Federal Reserve has engaged in what is called “quantitative easing”, buying up collateral from the banks and giving the banks money in return.
This has allowed banks to clean up their broken balance sheets. This process is not over and this is the reason why American interest rates are likely to remain at historically low levels for a long, long time. In addition, the US government has run a massive trillion-dollar budget deficit pump priming the economy.
Despite these efforts, the recovery in the US has been considerably weaker than previous recoveries from recession. According to a recent study by the US Council for Foreign Relations comparing this recovery with previous ones, the Council concludes that:
“The current recovery remains an outlier among postwar recoveries along several dimensions, particularly those that relate to housing. The Federal Housing Finance Agency’s house price index declined in the first quarter of the year, after rising for two consecutive quarters. Consumers remain reluctant to take on new debt and the stock of debt is lower than it was when the recovery officially began”.
This reflects the vicious deleveraging which has had to go on as people try to pay back debts and companies do likewise. Of course, because in the US mortgages are non-recourse, people can walk away from their houses without being shackled with the debt personally. This is in direct contrast to the Irish situation where one mistake in buying a house at the top of a boom will condemn you to a life of debt servitude. In the US, this is not the case as the loan goes with the property not the person.
In fact it is the housing market and the evidence that it is stabilising in recent months, despite an earlier setback, which gives most cause for optimism. Looking at the way the economy works, it is almost impossible to have a sustained recovery if there is on-going negative equity and too much debt around the neck of the average person. In the US, the debt problem is sorted by non-recourse mortgages and the fact that people move about a lot. And, as the housing market stabilises, the negative equity legacy for those still in the same properties will ease.
The central role of housing in the economy was again reiterated by William Dudley, president of the New York Fed bank, who acknowledged some improvement in housing of late, but said, last week, that “credit availability remains “impaired” and argued that, overall, the pace of the broader US economic recovery has been disappointing.
He went on to say that the housing market is “a key impediment” to economic growth in US. But as we look forward, the key drivers of the housing market, income growth, employment and demographics are moving in the right direction.
However, this process of emerging from too much leverage, swinging to too much deleveraging and back to normal recovery has to be facilitated by economic policy. This is the responsible thing to do. Deleveraging is a long, slow difficult process as we know here and as the private sector pulls in its horns, unless the government keeps demand buoyant by spending, it’s hard to see how the economy can recover.
Contrast this American approach with what is going on in Europe. As noted, the Americans are putting growth first and worrying about austerity later. The fact that interest rates and long-term interest rates are at their lowest level for decades suggests that the financial market is broadly supportive of this stance.
If, for example, the dollar was about to collapse under the weight of printed money or the US bond market was going to fall off the much discussed “fiscal cliff’, bond yields would be much, much higher.
The bond yield or the long-term interest rate is only the short-term interest rate plus a risk premium for adverse future events. Obviously the general consensus in the US is that the government and the central bank are broadly doing the right thing in nursing the economy gently back to health.
In contrast, the EU, faced with broadly similar problems of too much inherited debt and consumers who are not spending, is opting for a policy of austerity first and growth later. This is forcing the EU economy into an entirely unnecessary recession. Policy is exacerbating the slowdown and in so doing practically guaranteeing the expansion of long-term unemployment.
When seen against the pragmatic discretion deployed by US policy makers, Europe’s rigid, ideologically-driven approach encapsulated in the “fiscal compact”, must seem like an economic suicide pact. Europe has 25 million unemployed and short-term interest rates in the core are negative. If that doesn’t scream at you the need for a fiscal expansion in the eurozone, I don’t know what does! Today, as the new president in Washington contemplates the future, he can at least be reasonably satisfied that the economy will be moving slowly in the right direction for the first time in five years. Is there any European leader that can similarly look forward towards what Churchill described as the “broad sunlit uplands”? Well who’s fault is that?
David McWilliams’ new book ‘The Good Room‘ is out now from all bookshops.