Imbalance Of Power:

Are Double Dipping US Corporations Symptoms of a Double-dipper World Recession?

Listener 10 August, 2002.

Keywords: Business & Finance; Macroeconomics & Money

Almost all recent New Zealand forecasts have accepted the international conventional wisdom that the US economy was in recovery. However, some forecasters have private reservations that a ‘double-dipper may be on’.

A ‘double-dipper’ would be an unusually long contraction with a brief recovery (or expansion) in its middle. The US economy went into recession in March 2001, although the stagnation was not ‘officially’ recognised until the end of the year. By then, the Bush administration had made major tax cuts which seemed to arrest the decline, and begun a expansion. If there is a double-dipper, any recovery will be tentative, and the economy will soon return to a contractionary mode. It may be in recession already.

The view sees some very severe internal imbalances in the corporate sector. US share prices have been well out of line with the traditional relation with profits. Even hugely optimistic assumptions say they are a quarter too high, although the sort of calculations we did for the New Zealand market before the 1987 crash would suggests they are double the level they should be. We also learned from that crash that corporate profits can be misleadingly inflated . Scandal after scandal suggests a similar situation in today’s US.

The effect is that its shareholders and businesses have thought their assets and the income which flows from them are worth more than long run reality permits. The overvaluation enables a sort of short-term double-dipping into nonexistent wealth, spending assets they have not got resulting, eventually, in a nasty deterioration in their balance sheets. A fall in US sharemarket prices reduces the wealth consumers think they have, and makes it harder for businesses to raise capital investment, adding to the collapse in economic confidence.

Economic contractions are not as rapid or spectacular as sharemarket collapses. There was over three years between the US share price collapse in 1929 and the nadir of the economic depression in 1933. An unfortunate consequence of the public’s demand for constant news is that journalists focus on instantaneously available data – primarily from financial markets. This not only gives the data (and its commentators) a significance out of line with its real importance, but it obscures the remorseless unfolding of the real economic story which affects production, growth, consumption, and jobs, even if it takes much longer than between a couple of sound-bites.

Wont the Bush tax cuts prevent a collapse? Leaving aside they were badly targeted – the greedy were too busy looking after themselves to consider their economic impact – the success of this sort of Keynesian reflation depends upon the state of the financial system (and also what happens to the external account – another US worry I have not space to discuss here). This has been vividly illustrated by Japan, where numerous attempts to use a fiscal stimulus to wrest the economy out of the stagnation of the last decade have failed. Their banking system has too many bad debts. The monetary injections seem to go into easing rort balance sheets rather than adding to spending. Some commentators fear the same will happen in the US. Enron, WorldCom and others (plus more to come I’m afraid) are not the fundamental problem, but are illustrations of the widespread financial imbalances which are thought to underpin a double-dipper, and which would make it so hard to deal with.

Any US stagnation or contraction will affect the world economy, and a world recession will impact on New Zealand – probably harshly. Yet we may be compounding the external shock – or rather the Reserve Bank’s monetary stance may be. Whereas the US Federal Reserve is maintaining steady interest rates, the RBNZ – fearful of inflation – has hiked ours. One effect will be to discourage house building, business investment and to a lesser degree consumer borrowing. The reduced pressure on resources will – the RBNZ hopes – discourage upward pressures on prices and wages.

But pushing up interests rates faster than the rest of the world is also encouraging a capital inflow which pushes up the exchange rate. The June 2002 Treasury Pre-Election Economic and Fiscal Update observed that ‘since the start of the year the New Zealand Dollar has appreciated against all major currencies, but particularly against the United States Dollar’. They reported the Trade Weighted Index (which measures the average change in the exchange rate) was 12 percent higher than at the beginning of the year.

The good news for the RBNZ and consumers is that the New Zealand dollar costs of imports are 12 percent cheaper. That will be an effective restraint on inflation. The bad news for exporters is that their New Zealand dollar return is 12 percent down too. Lower export profitability means they will find it harder to export. Since exports are the growth engine of the economy, the RBNZ monetary stance is cutting back New Zealand’s long run growth rate, just as it did in the second half of the 1980s. Because the world economy boomed then, the New Zealand economy only stagnated. We may not be so lucky if this time there is a world recession.