Market Advisory Features

The Non-performing Country
The Fed Holds Off
Greenspan Reads the Runes
Financial Regulation in America
State of the Union: What Bush Did and Did Not Say About the Economy
Bush Takes on the “Axis of Evil”


The Non-performing Country

Feb 15th 2002
The Economist Global Agenda

President George Bush arrives this weekend to meet Junichiro Koizumi, prime minister of Japan, a country plagued by the triple menace of debt, deflation and political deadlock. Even now, the drastic surgery the economy needs may not be forthcoming

WHEN George Bush and Junichiro Koizumi met in Washington last June, it was the American president who seemed the more politically insecure and the Japanese prime minister who was riding high. Now, as they prepare to meet in Tokyo next week, their positions seem to be reversed. Mr Bush has the kind of sky-high public approval once enjoyed by his Japanese counterpart. Mr Koizumi's loss of popularity, meanwhile, has been swift and stunning. This may make him more helpless than ever against Japan's triple menace of debt, deflation and political deadlock.

That is why Mr Bush's anti-terrorism campaign will not seem the most pressing issue when he arrives on February 17th, starting a week-long tour of Japan, South Korea and China. All eyes will be on Japan's economic slide, and on Mr Koizumi's newest set of promises—to be unveiled for Mr Bush's benefit—that he will do something about it.

Those glancing in from a distance may find it hard to tell Japan's current mess from the general doom and gloom of the past decade. But people watching more closely see especially strong reasons to tremble now. The first is that deflation and depressed spending continue unabated, bringing fears of an accelerating downward spiral. Consumer prices have fallen every month for more than two years.

Only a few months ago many Japanese economists were still saying that Japan's deflation might be healthy, since lower prices make life better for consumers. Those optimists have gone silent, however, as falling prices have continued to be matched by dwindling jobs. Japan's unemployment rate rose to 5.6% in December, the highest since the second world war. More than a million heads of Japanese households are now out of work.

More jitters stem from Japan's rickety banking system, and from the common knowledge that the government must one day do more to deal with the banks' bad loans. Although this has been obvious for years, many investors fear the day of reckoning is near.

On April 1st, Japan will start a new financial year, which will set off a pair of decisive changes. Banks, which own lots of Japanese equities, will be made to value these shares at market prices. Because equity prices have fallen sharply, the banks will have to show losses of more than one-and-a-quarter times their operating profits. Although those losses have already occurred, admitting to them could prompt more depositors or investors to flee.

Depositors are anyway nervous, because of another change due on April 1st. After putting it off last year, the government will begin rolling back the blanket deposit insurance that it introduced in 1998. The first stage will affect only time deposits, and will limit insurance to 10m ($75,200) per depositor at each bank. Many depositors have already moved their money, spreading it around in 10m instalments and transferring much of the rest into other types of deposits, which will remain insured for another year. The risk remains that the partial repeal will cause bank runs. Some Japanese have been buying gold for safety.

These looming changes, by raising the odds that Japan's long-awaited crisis will at last arrive, leading to some kind of economic meltdown that could be cathartic but might be disastrous, have helped to send asset prices tumbling. Share prices have fallen yet again, to their lowest levels since the mid-1980s. The Nikkei 225 stockmarket average, which in its proudest moment in 1989 approached 40,000, now languishes at around 10,000.

Worse will follow if bond investors come to share the alarm. After running up fiscal deficits throughout the past decade's slump, Japan's official public debt has risen to 130% of GDP. The budget that Mr Koizumi wants to pass, which is modest by his ruling party's standards, will easily drive the ratio above 140% within a year.

This excludes the cost of the government's other liabilities, stemming from publicly-backed corporations, social-security promises, and, if it is forced to nationalise the banks, the cost of cleaning up their balance sheets. Japan's fiscal position is, in short, pretty dreadful. This has already prompted downgrades by the rating agencies: this week, Moody's said it might lower Japan's credit rating to the same levels as Poland and South Africa.

Even those onlookers who see Japan’s malaise as chronic but not at crisis-point, are fretting for another reason. Unlike most previous bouts of panic, this one has far more potential to cause trouble in the rest of the world, where much of East Asia is still in recession, and an American recovery is still shaky. Japan remains a big trader, investor and lender, so any collapse would affect all its counterparties.

Pinning the blame

Vested interests in Japan—among the bureaucracy, the politicians of the ruling Liberal Democratic Party (LDP) and the disproportionately powerful voting blocks that back it—are clearly the prime culprits for the country’s troubles. These groups benefit in some ways from Japan's malaise, especially from the fiscal gravy train that has rattled along unhindered throughout the slump.

Politically, therefore, Japan would find it hard to recover even if disinterested experts could agree on what it should do. Yet economic analysts continue to bicker among themselves. All agree, however, on Japan's need to inflate its way out of trouble. Its private and public debts are enormous. Falling prices make almost everything worse.

Unfortunately, a collapsed asset bubble followed by years of inaction have made it hard for Japan to achieve inflation, since expectations of flat or falling prices are so entrenched. Technocrats debate ways to fix this problem. One approach is to get the banks to finance Japan's fiscal deficit directly, bypassing the bond markets. Another is to print yen and use them to buy up foreign bonds. But most economists agree that, if Japan is to achieve inflation, the yen—already weak—will have to fall much further, perhaps to between 180 and 200 to the dollar, which will alarm Japan’s trading partners.

How has all this affected Mr Koizumi's calls for reform? He started off well, promising to clean up the banks, restrain government borrowing and derail the gravy train through “structural reform without sanctuary”. The wider public adored his brisk style of speaking, and his promises to inflict pain for the sake of future gain. When teamed up with his combative foreign minister, Makiko Tanaka, who promised to expose corruption and insubordination in her ministry, Mr Koizumi achieved strong public approval, with more than 80% of Japanese voters, at the high points, saying that they backed his government.

But three developments have helped to pull Mr Koizumi to earth. First, he could not reform much since the despised “resistance forces” in the LDP and the bureaucracy have watered down all his plans. Second, these forces, having bought time, have cashed in on the recession by persuading people that Japan needs to pursue “anti-deflation” (by which the LDP means more public spending) before structural reforms (which would cut off the tap). Thirdly, Mr Koizumi sacked Ms Tanaka, foolishly provoking a backlash and losing his only real asset, his popularity.

What happens now? Many of Mr Koizumi's reforms seem less likely than ever to happen. If asset prices continue to slide, the government may have to deal more actively with the banks' bad debts. More likely, it will keep muddling through. A mildly lower yen might, in the meantime, mildly boost exports; and Japan may get a boost in May and June when it co-hosts soccer's World Cup. Alas for Mr Koizumi, and for Japan, the real crisis that would force an acceptance of reforms could still take longer to arrive.


Financial Regulation in America

Feb 14th 2002 | NEW YORK
The Economist

America's top financial-markets regulator, Harvey Pitt, stands accused of being a soft touch. Not yet proven

AMERICANS boast that their capital markets are the best in the world. Enron's collapse might suggest a confusion of quantity with quality. Misleading accounting, analysts who cheerlead for companies rather than analyse them, and more: are America's markets really more transparent, and its investors better protected, than elsewhere?

If they are, they need to be more so. And, as the chairman of the Securities and Exchange Commission (SEC), Harvey Pitt has the responsibility for making the improvements. When he was nominated last May, questions were raised over his suitability. Could a lawyer who had represented some of Wall Street's greatest poachers—and who had often challenged the SEC in court—really prove a good gamekeeper? The fall of Enron, and its implications for regulation, multiplied the doubts. Mr Pitt had often represented the big five accounting firms, and he opposed the ban on auditors selling consulting services to clients that was sought by his predecessor at the SEC, Arthur Levitt.

Mr Pitt plans to confound his doubters by proving that detailed knowledge of the law makes him an ideal guardian of it. The Enron debacle, far from being a source of embarrassment, he says, has become “the poster-child for the agenda I had already laid out.” Perhaps. Enron's collapse has certainly forced him to lay out his agenda sooner than he planned. He is now even ready to support a ban on auditors selling non-audit services “if Congress decides that is necessary”. It probably will.

On February 13th the SEC proposed several changes to corporate-disclosure rules. Firms will immediately have to reveal transactions in company shares by executives, rather than waiting up to 45 days. Annual results must be posted within 60 days, not 90 days, as now, and quarterly results must be published within 30 rather than 45 days. Material changes to a firm's business prospects—anything from waivers of corporate-ethics rules for employees, to the loss of a large customer—must be disclosed at once.

Firms will also have to explain why they have chosen particular accounting treatments, and show how the numbers would have looked on different assumptions. The SEC has written to the New York Stock Exchange (NYSE) and Nasdaq, asking them to show how listing requirements could be used to force companies to strengthen audit committees and otherwise improve corporate governance. Within a couple of months, Mr Pitt plans to publish proposals for a system for regulating auditors, based on a private-sector body “aggressively overseen” by the SEC.

He also intends to force an agenda for greatly improving accounting standards on the Financial Accounting Standards Board (FASB). Here, previous SEC chairmen largely failed—often thanks to lobbying by accountants represented by Mr Pitt.

One of Mr Levitt's proudest achievements was regulation FD (for fair disclosure), which required firms to disclose material information to all investors at the same time, instead of favouring professional investors. Though promising that there will be prosecutions, Mr Pitt thinks that regulation FD falls short, because it allows firms to “tell everything to everybody, or nothing to anybody”. He wants to impose a “positive obligation” on companies to disclose material information as it occurs—and in plain English, not legalese.

Mr Pitt already claims success on the thorny issue of Wall Street analysts and their conflicts of interest. Guidelines published last week, in conjunction with the National Association of Securities Dealers, would restrict share ownership by analysts, make them explain their rating systems and disclose prominently any investment-banking relationship their firm has with the company being touted. Does this go far enough?

The chairman promises more “real-time enforcement”, including freezing the assets of likely villains so that there is money left for the victims. This year the commission has obtained two dozen court orders freezing assets, sharply up on previous years.

The SEC also wants to lay out a framework for competition among stockmarkets. Electronic trading systems threaten to fragment America's markets, making them less liquid. The SEC has been unsure over what to do. Mr Pitt says he wants as much competition as possible. He is exploring giving European exchanges more access to American investors. He says he will soon rule on applications by Nasdaq and Island, another electronic network, to be regulated as exchanges. The New York exchange, which stands to lose business, is lobbying against.

Raising capital effectively is another issue. Selling securities to the public is costly and slow, leading many firms to opt for private sales. That way, the public is denied plenty of decent investments, which end up only with sophisticated investors. Mr Pitt wants to integrate the SEC's disclosure regime with the system for raising capital, to make it easier for firms with good disclosure to raise fresh capital in the public markets.

As for the quality of investment advice, America's different securities laws treat types of professional advisers differently, even when they offer products and strategies that are more or less the same. Mr Pitt may try to harmonise the regulation of mutual funds, hedge funds, financial advisers and brokers.

Why does he think he can achieve so ambitious an agenda, when previous chairmen struggled? First, he thinks he can move faster by working with the private sector, not against it. Since September's terrorist attacks, and particularly after Enron's implosion, Mr Pitt claims, industry and regulators have worked together on reforms. Will everybody be so accommodating when there is less sense of crisis?

Second, the chairman thinks the commission can carry out its entire agenda without new legislation. In the 1990s the Federal Reserve used its own powers to undo much of the Glass-Steagall law that kept commercial banks out of investment banking. Similarly, Mr Pitt thinks he can transform market oversight by using the SEC's right to exempt firms and individuals from old regulations, giving the SEC wide freedoms to set whatever new rules it wants. He argues that broad exemptive authority was given by Congress to the SEC in 1996, but has never been used. The powerful interests at stake will no doubt challenge the commission's authority in court. At least the SEC should not be short of a good securities lawyer.


The Fed Holds Off

Feb 1st 2002
The Economist Global Agenda

At its January meeting, America's Federal Reserve left interest rates unchanged for the first time in more than a year. This appears to support those who believe that the worst is now over for the American economy. But new labour market data suggest the Fed is right to remain cautious

IT HAD to happen sometime. After a long period of aggressive interest-rate cuts—eleven in less than a year—the point was bound to be reached when the Federal Reserve, America's central bank, decided to call a halt. Since the beginning of January last year, interest rates have fallen from 6.5% to 1.75%. So with signs that the worst may be over for the world’s largest economy, the Federal Open Market Committee (FOMC), the Fed’s main policymaking body, seized the opportunity on Wednesday January 30th to take a breather from the relentless rate-cutting, and left American interest rates unchanged. It is a decision fraught with risk, as the all-powerful Fed chairman, Alan Greenspan, surely knows.

For policymakers, as well as businesses, economic slowdowns are acutely difficult to read accurately. The key challenge is to spot the turning points—both on the way down and on the way up. The picture is usually confusing, as some data give cause for concern, while other figures suggest less need to worry. During the current downturn, for example, the persistent optimism of American consumers for much of last year puzzled many economists. The latest labour market data, released on February 1st, are equally confusing.

Yet at the beginning of 2001, when economists and many businessmen were still trying to measure the speed and extent of the economic decline, and to assess the likelihood of recession, Mr Greenspan and his colleagues were quick off the mark. Without waiting for the regularly-scheduled meeting of the FOMC at the end of January 2001, the Fed took everyone off-guard by cutting interest rates at the beginning of that month, in response to business data which had alarmed Mr Greenspan. From then on, the Fed sought to stay ahead of the game.

In the autumn of last year, the National Bureau of Economic Research confirmed that the economy had actually gone into recession in March. This showed Mr Greenspan had been right to act quickly. As the economy went into a nosedive, some started openly to criticise the Fed chairman’s policies during the late 1990s: they argued that the Fed should have acted to curb market exuberance before it did. But whatever mistakes might have been made before the slowdown, few have questioned the wisdom of the Fed’s actions after it began.

Now, though, Mr Greenspan is once again in trickier territory. There have recently been mixed signals from the chairman and some of his colleagues. In a speech in San Francisco on January 11th, Mr Greenspan said it was still premature “to conclude that the forces restraining economic activity have abated enough to allow a steady recovery to take hold.” But when he testified before the Senate Budget Committee on January 24th, he seemed subtly to have shifted tack. “There have been signs,” he noted, “that some of the forces restraining activity have started to diminish and that activity is beginning to firm.” In its statement after the meeting on January 30th, the Fed concluded that the signs of strengthening economic activity have become more prevalent.

And they have. Figures published on February 1st showed that unemployment unexpectedly fell in January, to 5.6%, compared with 5.8% in December. (They had been expected to rise further.) Most significant, though, are the advance GDP figures for the final quarter of last year, published on January 30th and showing a small rise: 0.2% at an annual rate is admittedly tiny, but it contrasts with widespread expectations of a further fall. The figures should be treated with great caution—they will be revised twice more, and these revisions could be significant enough to change the plus sign to a minus. Moreover, much of the increase comes from a spectacular surge in durable-goods orders, which rose at an annual rate of more than 38%. This largely reflects a big rise in car sales in response to temporary special offers, including interest-free credit, used by the car industry to boost sales. At least some of the big jump in demand simply reflects orders brought forward from the future, rather than a genuine upturn in sales. Caution is needed when analysing the unemployment figures, too: payroll figures suggested that the number of people in work also fell, nearly four times as much as most economists had forecast.

Nevertheless, quite a bit of the latest data suggests economic confidence among consumers and businesses may, slowly, be picking up. This arguably strengthens the Fed’s decision to pause before deciding whether further interest rate cuts might be needed. After all, the monetary easing which has already taken place is still working its way through the economy. There has already been some fiscal easing as well, with tax cuts and government spending increases; and President George Bush, in his state of the union address on January 29th, made it clear that much more government spending is on the way.

Some economists, and no doubt some members of the FOMC, have recently begun to express concern that as interest rates fell closer to zero the Fed would lose room for maneouvre. Some of the more extreme pessimists keep thinking about the Japanese predicament, where deflation has meant that even zero interest rates have done nothing to help kickstart the economy. Worries about Japanese-style deflation, though, seem misplaced in the American context. Prices aren’t falling in America.

But inflation is, which is one argument for further interest-rate cuts: to ensure that the decline in interest rates is real, rather than simply nominal. And since it is hard to see inflation as a serious threat in the immediate future, it is reasonable to argue that the Fed could continue to cut rates consistent with its statutory obligation to promote maximum employment, stable prices and moderate long-term interest rates.

The inscrutable Greenspan

Second-guessing Mr Greenspan and his colleagues is a pastime from which many economists and commentators derive much pleasure, if not much enlightenment. It is nevertheless possible to infer from the latest Fed statement that the decision to leave interest rates unchanged does not necessarily mark the end of the prolonged rate-cutting spree. The risks, says the Fed, “remain weighted mainly towards conditions which may generate economic weakness in the future.” By the time the FOMC meets again, in mid-March, the Fed chairman is no doubt hoping that those signs of recovery will have further strengthened. He does not seem ready to commit himself too firmly for now, though.


State of the Union: What Bush Did and Did Not Say About the Economy

30 January 2002


The U.S. economy was a major focus of the State of the Union address on Jan. 29. But as they did in President George W. Bush's speech, economic concerns this year will take a back seat to prosecuting the war. New defense spending will trump a stimulus package, and global economic issues will receive scant attention from Washington.


Within the first minute of his State of the Union address on Jan. 29, President George W. Bush came right out and boldly declared that the U.S. economy is in recession. The president clearly hoped to build momentum for a floundering economic stimulus package, yet he largely failed to address a number of global economic issues in his speech.

The Bush administration will have trouble with both issues this year. With the U.S. economy reviving faster than expected and new proposals for defense spending on the table, the president's stimulus package has little chance of congressional approval. Meanwhile, the administration will remain focused on the war on terrorism and domestic issues -- overlooking a global economic scene that grows increasingly perilous.

The U.S. economy should recover nicely with or without a stimulus package, though corporate America will lose out on tax cuts. Other domestic initiatives might also get crowded out by new defense spending. Globally, the United States runs the risk that mismanaged economic problems in countries like Argentina will deepen and devolve into wider security threats.

During his speech, Bush aggressively used a term that most sitting presidents -- with lower popularity ratings -- avoid like the plague: recession. He clearly hoped to use the recession to push Congress into passing his economic stimulus package. But his claims were contradicted Jan. 30 by a Commerce Department report saying the U.S. economy actually grew by 0.2 percent in the fourth quarter, far better than consensus expectations of a 1 percent contraction. If those figures are not revised downward, the United States actually will have avoided the most common definition of a recession: two consecutive quarters of GDP contraction.

The fourth quarter growth figures -- and other positive economic news like strong new home sales, a 2 percent rise in December durable goods orders and a sharp rise in January's consumer confidence numbers -- hurt the president's case for an economic stimulus package. His call for massive new defense outlays may have the same effect.

As expected, the primary focus of the State of the Union speech was the war against terrorism. Bush reminded the American public in no uncertain terms that the war against al Qaeda is not yet won and that foreign and domestic security will require a lengthy and expensive military commitment. He then trumpeted -- to loud applause -- a proposal for the largest defense budget increase in 20 years, estimated at $48 billion.

Between the stimulus package, new defense spending and Bush's demand that Congress act in a fiscally responsible manner, something has to give. It will most likely be the stimulus package. Public support for the war is still very high, meaning opposition to defense spending increases will be limited. A Wall Street Journal/NBC News poll last week showed that 64 percent of Americans think most of the military action in the war on terrorism lies ahead.

The Democrats certainly won't stand in the way of financing the war. What they will oppose, however, are stimulus proposals involving corporate tax breaks. Other programs could also fall victim to defense spending, such as measures to insure employees' pensions and 401K plans. Rather than putting any federal money behind such programs, Congress more likely will respond to the Enron debacle by passing new investment safeguards and strengthening accounting standards and disclosure requirements -- as Bush proposed.

Much can also be taken from what Bush did not say in the State of the Union address. He largely ignored global economic issues that have been pushed aside by the war and the domestic economy.

For instance, he made no mention at all of Japan or Argentina, the two most serious challenges facing the global economy. Japan, the world's second-largest economy, is enduring its fourth recession in a decade while Argentina's current government is the fifth in two months. But like Bush's speech, the administration's agenda is dominated by two overwhelming issues: the war and the domestic economy. Global economic issues are a low priority by comparison, especially for an administration that is less ideologically interventionist than its predecessor was.

Washington ignores the world at its peril. Inaction on global events unrelated to the war will damage the United States' reputation as a global leader and could directly impact the global economy and global security for the worse.

One case in point: Argentine Foreign Minister Carlos Ruckauf left Washington nearly empty-handed Jan. 29 after two days of meetings with Bush administration and International Monetary Fund officials. Argentina's government is on thin ice right now, and without some infusion of outside cash, it could fall -- possibly sinking South America's second-largest country into anarchy. Such a collapse could threaten the stability of the entire continent and feed already strong anti-American sentiments in Latin America.

Such an outcome would certainly demand more of Washington's attention.


Bush Takes on the “Axis of Evil”

Jan 30th 2002
The Economist Global Agenda

A triumphant President George Bush, riding high in the polls, used his first state-of-the-union speech to declare that America’s war on terror has only just begun, and to warn North Korea, Iran and Iraq—an “axis of evil” in his words—that the United States will do what is necessary to protect itself and its allies

Bush addresses a nation at war

THE American president’s state-of-the-union speech, delivered every year before a joint session of Congress, has become one of those political rituals which attracts enormous attention in Washington, and briefly dominates the news in the rest of the country, but is usually quickly forgotten. President George Bush’s first state of the union could well prove an exception. Delivered on Tuesday January 29th, the speech contained the obligatory calls for unity and the customary patriotic flourishes—more intense this year than most because of the emotional mood following the September 11th terrorist attacks—but it also contained stark warnings that Mr Bush’s administration has ambitious plans to project American power throughout the world, not only to combat terrorism but also to restrain or defeat “outlaw” regimes which it believes threaten international peace.

Mr Bush provided few details of how this would be done, and set no deadlines, but he described a newly militant and aggressive America. If his words do not prove to be empty rhetoric, his speech could mark the beginning of a far more assertive American foreign policy which is bound to unsettle allies and foes alike.

Mr Bush has delivered this message before, stating many times since last year’s attacks that the war on terrorism would be a long one, and warning even during the 2000 presidential campaign of the threat posed by so-called “rogue regimes”. So in this sense there was little new in the speech. And yet what was striking about it was his effort to wrench the attention of Americans back to these threats, and to present himself first and foremost as a wartime president. Polls have indicated that America’s economic recession and worries about job security are now beginning to dominate the attention of most people in the United States. Mr Bush dealt with these issues as well. But the bulk of his speech, and its most emotive and eloquent passages, were about the military and terrorist threats facing the nation. He seemed at pains to persuade Americans that these remain extensive, to stress the widening scope of America’s response and to rally support for more spending to support it.

“Thousands of dangerous killers, schooled in the methods of murder, often supported by outlaw regimes, are now spread throughout the world like ticking time bombs, set to go off without warning”

American forces had not only defeated their enemies in Afghanistan, said Mr Bush, but had discovered new threats there. “We have found diagrams of American nuclear power plants and public water facilities, detailed instructions for making chemical weapons, surveillance maps of American cities and thorough descriptions of landmarks in America and throughout the world. What we have found in Afghanistan confirms that, far from ending there, our war against terror is only beginning.” The 19 hijackers of September 11th were trained in Afghanistan’s camps, he claimed and so were “tens of thousands of others”. This meant that “thousands of dangerous killers, schooled in the methods of murder, often supported by outlaw regimes, are now spread throughout the world like ticking time bombs, set to go off without warning.”

American forces had not only fought these terrorists in Afghanistan, but were already active in helping to root them out in the Philippines and Bosnia and were patrolling the coast of Africa to stop them from establishing camps in Somalia. America would do whatever it took to pursue them, with the help of other nations if possible. “But some governments will be timid in the face of terror. And make no mistake about it: If they do not act, America will.”

But the threat, said Mr Bush, does not end there. In addition, there are also outlaw regimes intent on acquiring weapons of mass destruction and they sponsor terrorism. He named three specific countries: North Korea, Iran and Iraq. “States like these, and their terrorist allies, constitute an axis of evil, arming to threaten the peace of the world.”

Fingering Iran

The surprise on the list is Iran. Last year America had seemed at pains to win the support of Iran, an old adversary, for its campaign in Afghanistan and anti-terrorist efforts. It had also been intent on encouraging moderates within the Iranian regime. American officials had welcomed Iran’s condemnation of the September 11th attacks and praised its constructive approach to the negotiations in Bonn setting up Afghanistan’s interim government.

But lately relations have deteriorated. America accused Iran of sending an arms shipment, intercepted by Israel earlier this month, to Palestinians. And it repeated its long-standing accusations that Iran possesses biological weapons and that its purchase of ballistic missiles and other technology poses an international threat. This month Mr Bush publicly warned Iran not to interfere in Afghanistan, after reports that it had been supplying warlords there with money and weapons.

After Mr Bush’s speech, senior administration officials told reporters not to conclude that his naming of these countries was a prelude to military action, or even a promise of it, and that other “weapons” in America’s arsenal could be used against them, such as economic sanctions and diplomatic pressure.

Congress united, briefly

And yet many people, both at home and abroad, are likely to interpret Mr Bush’s words as just that: a warning of future military action, even if it is not imminent. He described these states as threats to world peace, warned that remaining indifferent to the threat would be “catastrophic” and added: “We’ll be deliberate. Yet time is not on our side. I will not wait on events while dangers gather. I will not stand by as peril draws closer and closer. The United States of America will not permit the world’s most dangerous regimes to threaten us with the world’s most destructive weapons.” And he announced the largest increase in defence spending in two decades. Many other countries will now be wondering what Mr Bush intends to do next.

At least for the foreseeable future, Mr Bush is unlikely to meet much opposition at home to his militant rhetoric or even to bold forays abroad, should he decide to make them. His approval ratings in opinion polls are above 80%, extraordinarily high by any standards and this is mostly due to his response to the September 11th terrorist attacks. The Democratic Party’s response to his speech did not take issue with what he said about fighting terrorism or American security, and repeated some of his points. But what he said on the economy and related subjects was more contentious and more partisan.

Budget politics

In a congressional election year perhaps this is not surprising. Predictably, Mr Bush did not mention the name of Enron, the Texas-based energy company whose collapse in December has been accompanied by a series of accounting scandals and which threatens to taint his administration. But he did concede the broad point that tighter regulation of corporate behaviour may be needed, something of a U-turn presumably designed to fend off Democratic attacks. He also seemed to concede ground to the Democrats in talking about the need to extend unemployment benefits and health care for the jobless.

But on the issue of the federal budget, which could become the battleground for this autumn’s election, there was no retreat. He praised his own tax cut and reminded Americans that they had received some of it already. In fact, he went further, making promises which could come back to haunt him. He promised a big increase in defence spending and homeland security but did not explain how these were to be paid for. Many analysts argue that it has largely been the reduction in defence spending which enabled America to begin running budget surpluses in the 1990s. And he talked about making Social Security financially stable, but his government has already raided the Social Security fund this year and next to balance the budget.

But most of all, in a brief flourish he promised to make his tax cuts permanent. If really implemented, this could have huge implications. The tax-cutting legislation he forced through Congress last year contains a provision reversing the tax cuts in 2010. Although it is easy to doubt that this will happen, it is this reversal which is projected to provide up to half the budget surpluses over the next 10 years (ie, to 2012). Excluding Social Security, the budget is not expected to return to surplus until 2010 in any case. And even these calculations do not take account of Mr Bush’s plans for increased defence spending. In short, Mr Bush telling Americans that they can have more defence spending and permanent tax cuts even while restoring economic growth and remaining fiscally prudent. Achieving all these things at once looks impossible.


Greenspan Reads the Runes

Jan 28th 2002
The Economist Global Agenda

Amid growing optimism about the outlook for the American economy, the Federal Reserve meets this week to decide whether to cut interest rates again. The decision looks to be more finely balanced than for many months

In the hot seat

SPECULATIONS about which way Alan Greenspan will jump is once again a favourite preoccupation for economists. The renewed interest is easily explained: Mr Greenspan will chair a two-day meeting of the main policymaking committee of the Federal Reserve—America’s central bank—this week, and attention is focused on whether another cut in interest rates is on the cards. Rates were cut 11 times during 2001 but, as optimism about an imminent economic recovery has strengthened, so has speculation that the Fed will decide to call at least a temporary halt to interest-rate cuts.

The guessing-game has been unusually intense lately, partly because of the belief among many economists that the worst is over for the American economy; and partly because the signals from Mr Greenspan and the Fed have been mixed. In a speech in San Francisco on January 11th, the Fed chairman appeared to be warning against optimism. “It is still premature,” he said, “to conclude that the forces restraining economic activity here and abroad have abated enough to allow a steady recovery to take hold”. Some read that as meaning that another rate cut was on the way.

Since then, though, comments from other Federal Reserve officials have suggested greater optimism about the short-term outlook. And when Mr Greenspan testified before the Senate Budget Committee on January 24th, he too seemed subtly to have subshifted tack. “There have been signs,” he noted, “that some of the forces that have been restraining the activity of the economy over the past year are starting to diminish and that activity is beginning to firm.” To some observers, this means: no rate cut.

The uncertainty about the Fed's intention mirrors the uncertainty about the economic outlook. Since the American economy went into a nosedive at the very end of 2000, the economic data has been maddeningly difficult to read. Even well into last year, many economists reckoned that a recession could be avoided, pointing to the resilience of the American consumer in the face of falling share prices, slumping corporate profits and sharp declines in industrial production. Since consumption accounts for about two-thirds of American GDP, the optimists argued, the consumer’s apparently unshakeable addiction to shopping would see America through the difficult patch.

The terrorist attacks of September 11th brought a sudden change in sentiment as consumer confidence collapsed. It soon became clear that many of the problems initially attributed to the aftermath of the attacks were well entrenched before then. And finally came official confirmation (from the National Bureau of Economic Research) that the American recession had begun last March. Almost immediately the debate shifted, from whether America was in recession, to when the recession would end.

Again, the optimists are out in force. Most—but definitely not all—economists are confident that a weak recovery will start sometime during the first half of the year and strengthen thereafter. They point to the likelihood of a slowdown in inventory reduction, the effects of last year’s substantial cuts in interest rates working through the economy, and lower energy prices as being factors which should help stimulate recovery. They have also been cheered by the substantial recovery in share prices from the low points they reached early last year.

Mr Greenspan himself has stressed the potential for new technologies to improve corporate rates of return; in his testimony on Capitol Hill last week he cited survey evidence suggesting that many American managers still saw scope for exploiting recent advances in technology, and he himself seems firmly to believe that productivity growth will continue. Ever cautious, he was careful to balance these remarks with the observation unemployment could act as a brake on household spending and, because spending held up better than expected last year, there was less scope for it to contribute to recovery this year.

One area where Mr Greenspan was silent, though, was on the debt position of consumers and corporations. Total private debt continued to rise in 2001, in contrast to every previous recession, when it fell. Corporate debt has surged to record levels, in relation to both GDP and profits. The debt-service burden of households is now nearly 14% of their incomes, higher than on the eve of the 1990-91 recession. The combination of low inflation and the aggressive interest-rate cuts made by the Fed in the past year have encouraged people to carry on borrowing. This may have made the recession less deep than it might otherwise have been. But it may also have stored up problems for the future.

If consumers suddenly decide to curb their borrowing, any recovery could slow, or even go into reverse. At the very least, historical and international comparisons suggest that a large debt overhang is likely to mean that the recovery is slow and anaemic. One response to that would be further interest rate cuts but, perversely, this could encourage more overborrowing. So Mr Greenspan has a dilemma. And yet despite the danger of encouraging more borrowing, he could decide to cut anyway. For one thing, inflation is continuing to fall, so nominal interest rates need to carry on falling to prevent a rise in real interest rates. And yet continued cutting runs up against arithmetic. As nominal rates approach zero—they are now down to 1.75%—there is less to cut, and Mr Greenspan and his colleagues lose room for manoeuvre.