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The U.S. Economy: Stuck in Neutral


The U.S. won't be able to export its way out of this slump as a global currency war looms

When countries suffer financial crises, history shows, they generally climb back out of them via exports. Their currency falls, and the parts of the world that didn't go through a financial crisis help them out of their hole by snapping up their goods and services and putting their people back to work.

This time it's not so easy. The financial crisis wasn't felt in just a single country. Last year was the first year since the Great Depression in which the economic output of the entire world declined. What's more, the countries that are growing quickly now, such as China, aren't willing to step up their imports to stimulate growth in the weaker economies. China and others are actually depressing their currencies to gain or maintain an outsized share of the stunted global demand. Brazilian Finance Minister Guido Mantega warned on Sept. 27 of a "currency war." The problem is that it's a mathematical impossibility for all countries to grow by keeping exports high and imports low. "There isn't another planet to export to," says Paul Krugman, the Nobel prize-winning Princeton University economist and New York Times columnist.

What now? For the U.S., the world's biggest economy, the question is what it will take to restore healthy growth, if it's not going to be trade. Economists interviewed by Bloomberg Businessweek and Bloomberg News offered an intriguing variety of answers, from technology to animal spirits to the simple passage of time. Most, however, say the U.S. recovery could remain subdued for several more years—and there's still a possibility that growth will stall out altogether, sending the economy back into a recession.

Complicating matters, the hole from which the U.S. economy needs to escape is unusually deep. As the accompanying chart shows, employment in September remained 5.6 percent below its December 2007 peak. In four of the five previous recessions going back to 1970, employment had bounced back to new highs by this stage. The only exception was the aftermath of the 2001 recession, in which employment was 1.8 percent below its pre-recession peak at this stage.

The risk is that the economy will get stuck in a rut. Companies won't hire and increase production because they don't see any demand, and consumers won't spend because companies aren't hiring and because they're still trying to increase savings to make up for the destruction of household wealth in the financial crisis. "The effects of financial crises tend to be really, really protracted," says Krugman. "Japan is still a depressed, fragile economy 18 years after its banking crisis. If you compare where we are to the early stages of Japan's lost decade, we're doing worse. We've got a deeper slump, more unemployment, and overall a weaker policy response."

On Oct. 5, Goldman Sachs (GS) said there's about a 25 percent to 30 percent chance that the economy will dip back into recession. Goldman's chief U.S. economist, Jan Hatzius, predicted that the unemployment rate will rise back to 10 percent in early 2011 and noted that in the postwar U.S. economy, "we have never seen an increase in the unemployment rate (on a three-month moving average basis) of more than one-third of one percentage point that did not coincide with or foreshadow a recession."

Technological innovation is one potential savior. Edmund S. Phelps, a Nobel prize-winning economist at Columbia University, says "there is a rising reservoir of new, undeveloped, untried methods. At some point, the dam will burst." In Phelps' scenario, some entrepreneur will try to get a jump on his or her competitors by investing heavily in a new technology. Rivals will be forced to respond to avoid losing market share, and a virtuous upward spiral will begin.

Or maybe wear, tear, and obsolescence will come to the rescue. Companies can't put off replacing old structures and equipment forever, note Phelps and Hatzius. Housing construction is so slow that "it is almost mathematically impossible to see another big drop in it," Hatzius wrote Oct. 5.

The U.S. private sector is gradually working off its over-indebtedness. Ricardo J. Caballero, an economist at Massachusetts Institute of Technology and an expert on international financial crises, wrote in an e-mail exchange that the damage from the financial meltdown in the U.S. "takes some time to repair, perhaps a couple of years, but not a decade." In contrast to Japan, Caballero wrote, the U.S. has healthy corporate profits and productivity growth and lacks the "zombie" companies that sap the economy's strength.

Perhaps the U.S. economy's salvation lies in dullness. That, anyway, is what former Federal Reserve Chairman Alan Greenspan said on Oct. 7 at the Bloomberg FX10 conference in an on-stage interview with Bloomberg's Tom Keene. Greenspan said that it's useless to try to stimulate business executives' animal spirits as long as they're still fearful of another financial calamity. What's required, he said, is an extended period of calm—long enough for executives to regain their confidence and start thinking about new opportunities again. In other words, Greenspan said, "boredom."

The bottom line: With several countries using their currencies to prop up exports, the U.S. likely will need technological innovation and time to recover.

Coy is Bloomberg Businessweek's Economics editor.

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