The Hindu : U.S. economy: the war at home

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Friday, Dec 12, 2003

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U.S. economy: the war at home

By Sudhanshu Ranade

The interntional flow of capital will now begin to factor in the impending and possibly large fall of the dollar.

ONLY ONE of the Democrats in the ring for the American presidential elections next year voted against the invasion of Iraq. And now that things have gone so terribly wrong, none of them has a clue on what to do about it. George W. Bush can, at least, honestly say he is trying. Consequently, the Democratic campaign is largely focussed on the state of the United States' economy: "this is a President who lost 3 million jobs in three months," say some advertisements; while others speak of a President who gives hefty tax cuts to corporates "who then shift their headquarters to Bermuda — and their jobs to China."

According to a BBC report last Saturday, "The latest estimates of GDP, released by the U.S. last month, showed growth in three months to September hit an annualised rate of 8.2% — the highest for nearly two decades." This, however, does not seem to have made much of a dent in the employment situation. According to a report of the U.S. Department of Labour, titled "The Employment Situation: November 2003", "Both the unemployment rate, 5.9%, and the number of unemployed persons, 8.7 million, were essentially unchanged in November", while the "jobless rate is down slightly from midyear". According to graduate macro-economic textbooks, fiscal policy and monetary policy are the two main instruments available to a government to stimulate an economy — as distinct from employment. Given the way President Bush has, in less than three years, converted the huge fiscal surplus that he inherited into an enormous fiscal deficit, this particular policy instrument is no longer an available option. To make things worse, while the reason that increased government spending works is that it funds productive activity in the economy, most of Mr. Bush's increased expenditures have been earmarked for spending outside the U.S. for reasons that are too well-known, and too recent, to need recapitulation.

Monetary policy stimulates the economy mainly by cutting interest rates, which makes it more profitable for domestic investors to invest in the U.S. or elsewhere depending on whether you have, say, home ownership and small businesses in mind or large American manufacturers, producing products ranging from toys to computers, which earn larger profits by creating jobs where labour is cheaper than in the U.S.

In any case, the U.S. Federal Reserve Chairman, Alan Greenspan, has already cut interest rates to near zero levels, the lowest in 50 years. One effect of this has been to send financial sector investors scurrying in search of the more lucrative returns that can be earned in countries with far higher rates of interest such as India. This is an important reason for our huge pile-up of forex reserves, which we point to with pride: despite the apprehensions of those who realise that, given the degree of capital convertibility that has been ushered in, tides are no longer a one-way street, capable of being stopped by a mere command.

Having taken a look at the light weaponry in the U.S. arsenal, it is time to turn our attention to bunker busters: namely the use of Exchange Rate Policy as a tool to stimulate the U.S. economy, while simultaneously stimulating employment as well. The U.S. has for years been trying, using "all and any means at its disposal", to get other countries, particularly China and Japan (the latter can more easily be stampeded than the European Union, the former has anyway refused to budge) to `revalue' their currencies to `more realistic levels'. This means levels that will help increase the flow of goods produced in the U.S. to those countries while simultaneously increasing the prices of their goods in U.S. markets, thereby helping cut the rate at which manufacturing jobs are being lost back home.

In his testimony before the Senate Committee on Banking, Housing and Urban Affairs on October 20 this year, the Treasury Secretary, John Snow, in effect signalled the administration's intention to change track. Devaluing the dollar could accomplish the same purpose; and, more to the point, was in the realm of practical politics. A strong dollar, no doubt, ensures a red-carpet welcome for Americans (and NRIs) travelling abroad, be they tinkers, tailors or candlestick makers. But it does not help them keep their jobs back home. What profiteth a strong-dollar backed big spender to have the whole world at his beck and call, if there is a chance that he might end up losing his `soul'. It is this concatenation of circumstances that finally persuaded key American decision makers to `allow' the dollar to begin to slide. The dollar stood at an 11-year low against the pound sterling this Monday, while the euro was worth a dollar and 22 cents.

To sum up, this is a war that Mr. Bush might just be able to pull off without being left high and dry as he was in Iraq after the tide had receded. As for India, having decided to stay out of active involvement in the occupation of Iraq, we ought not to leave to chance the possibility of getting caught up or taken for a roller-coaster ride in this other war that has now begun. The differential in the rate of interest will remain, but the international flow of capital (between alternate destinations) will now begin to factor in the impending and possibly large fall of the dollar. We should not allow ourselves to be caught napping; not when we are told night and day that `the Citi never sleeps'.

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