Fear not. America will not go bust. At least not in the sense of being unable to cover all of the IOUs it has peddled to China and other investors. After all, hidden in some Washington and Fort Worth, Texas basements are the printing presses that turn out dollar bills on command. So if America â s creditors turn nervous or nasty, the Treasury can always crank up the presses, produce new bits of paper adorned with pictures of American presidents, and redeem its outstanding notes and bonds.
Which isn â t much comfort to those holding our IOUs, since the flood of dollars would have a lot less purchasing power than those the creditors lent to America. That â s why the Chinese and other countries have begun the search for ways to avoid piling up more Treasury bonds. Not easy to do: China runs a large trade surplus with the United States, and so has more dollars flowing into its vaults than it would like, and to earn something on those dollars uses them to buy Treasury IOUs. Of course, China could allow its renminbi to appreciate, making its products more expensive in the US, but that would throw out of work millions of workers who might begin to wonder whether the freedom they have been sacrificing in return for export-led prosperity and good jobs is any longer a good trade-off. The last thing the regime wants is for already-simmering unrest to boil over into full-scale rebellion.
So for now, the Chinese have to continue recycling the dollars they earn in trade into Treasury bills, although they are reducing the portion of their export earnings tied up in dollars, and are hunting for ways to do deals that bypass the dollar completely — pay yen to Brazil for oil, and accept reals for made-in-China products.
Which partly explains the recent weakness of the dollar, and the reduced relative attractiveness of what are deemed virtually risk-free Treasury obligations. But only partly. The world is becoming a less scary place. The world â s financial system will not implode, thanks in part to vigorous government action to shore up troubled banks.
Here in America, most banks passed the stress tests — it is not agreed that these tests were quite as stressful as Treasury Secretary Geithner would have us believe — with flying colors, and those that did not (Citigroup, Wells Fargo, Bank of America) are raising capital to bring their books up to snuff. Almost all leading banks want to repay the money that some begged for and others had forced upon them by then-Treasury Secretary Hank Paulson. Nothing focuses a banker â s mind like restrictions on his bonus.
None of this means that the banking system as a whole is out of the woods. Waiting down the road for the biggest banks is an accounting rule that will force them to take onto their balance sheets troubled entities that they have so far treated as off-balance sheet businesses, and a change in Federal Deposit Insurance Corporation (FDIC) rules that will raise the premiums charged for deposit insurance.
Meanwhile, all is not well for the regional banks. They are heavily invested in mortgages on commercial real estate, and everyone seems to feel those are the next loans for which repayment is not a certainty. Worse still, The Lindsey Group estimates that about half of the $500 billion in commercial property debt that needs to be refinanced in the next two years â will not be able to be refinanced or rolled over on the same terms. Keys to thousands of properties will be given to creditors and fire-sales will become more common. â Lindsey â s estimate is about in line with that of Richard Parker, head of research in this area for Deutsche Bank. Which is why triple-A rated bonds backed by mortgages on shopping malls, office buildings and other commercial properties are yielding more than 10%. Retailers are hurting, some stores are closing, many shopping malls echo to the footsteps of a hardy few shoppers or the click-clack of the flip-flops of teenage mall rats undoubtedly taking a bit of time off after heavy doses of Thackeray, Shakespeare, Trollope and other favorites.
Meanwhile, many of the professional firms that had been competing for prime office space in Manhattan, Chicago and other cities are no longer in expansion mode. Indeed, they are shrinking, often hoping to sublet unneeded space in the process. In Manhattan, three out of every four office towers have sublet space available. This depresses the price of newly built space, for which the demand is anyhow at rather a low ebb.
Then there is the housing market. Prices continue to decline, and although data from various sources are not consistent, it is safe to say that prices are now about 20% below last year â s levels in most markets, and still headed downward, seemingly at an accelerating rate. â The reacceleration in the pace of decline is not that large, but is somewhat surprising especially in the context of very low mortgage rates, â opines Goldman Sachs â economic team. And retailer Home Depot, closely in touch with trends in the housing market, sees little light at the end of the tunnel. Frank Blake, the company â s president, says, â We are concerned about the accelerating rates of foreclosures, particularly in the western part of the country. â Even New York City is feeling the pinch: residential rents are down about 7%, and the Hamptons house that brought a two-month summer rental of around $230,000 can be had this season for something like a mere $175,000.
Perhaps worst of all is the macroeconomic outlook. The federal debt, which once stood at about 40% of GDP is budgeted by President Obama to rise to 80% in 10 years, and many observers are saying that 100% is a more realistic estimate. Economists have a rule-of-thumb that suggests that such a high debt:GDP ratio will drive interest rates up by somewhere between 1.25 and 1.5 percentage points, which would surely slow the economy to a crawl. An alternative, says Stanford professor John Taylor, would be to inflate our way out of the problem — which would take a 100% rise in the price level over a ten-year period. Unless, of course, rumors that the administration is planning to cut into the deficit by introducing a national sales tax prove correct. It might be a shrewd move by the President, since exempting, say, $35,000 of spending from the tax would make it less regressive and therefore more attractive to Democrats hunting for funds with which to pay for Obama â s health-care program. Better still, it would be difficult for conservatives, who have long called for such a tax, to oppose it. Of course, conservatives have always seen a sales tax as a substitute for, rather than an addition to, current levels of taxation on incomes, but such an offsetting reduction is not in the cards.
This tale from the dark side is designed to accomplish two things. First, to alert those who see green shoots wherever they look that there remain plenty of weeds prepared to strangle the healthy growths. Second, to satisfy readers who feel I am too optimistic, and do not see the dangers lurking behind every new statistic.
That done, let me turn to the economic outlook as revealed both by the latest data and my informal surveys. House prices might be dropping, but the new, lower prices are beginning to attract investors into the market for foreclosed houses. Various groups have been put together to bid on hundreds of such homes at each auction, and then rent them to the previous owners at prices the tenants can afford, and at the same time yield a decent return to the investors. Add first-time home buyers who are priced into the markets from which they were previously excluded, and you have the beginning of a reduction in the inventory at the bottom end of the market.
There is also anecdotal evidence that buyers at the higher end of the housing market are being attracted by low interest rates to begin availing themselves of the relative bargains to be had in many cities. That is why the recent declines in home construction have been confined to multi-family dwellings. Construction of single-family homes rose slightly in March and then by a more significant 2.8% in April, which has sent the index of home-builder sentiment up for the first time in a long time. But note: builders are tending to build smaller and less expensive homes than in the past.
That development in the housing market would be consistent with the latest data on consumer confidence. The Conference Board reports that its index of consumer confidence jumped from 40.8 in April to 54.9 in May, the largest one-month increase since 2003, the highest level in eight months, and way beyond what economists were expecting. It seems that the rising stock market is buoying confidence, and that rising confidence is driving up share prices. That is a feed-back cycle that is susceptible to change with a spate of bad news. But the rosier view is also due to the fact that the jobs market is not deteriorating at the rate prevailing a few months ago.
What to make of these contradictory data? I have always found that it is a good idea to go to the people on the hard end of the recession — retailers. So I spent a week in New York talking with retailers, and have been listening to others here in the Washington area: proprietors and salesmen in clothing stores, costume and higher-end jewelry shops, furniture and antique dealers, wine merchants. A few say business is terrible. But most, the vast majority, tell the same tale. Business fell off a cliff last October, and then stayed at levels that had many considering going-out-of-business sales. But in April business picked up, and has continued to improve in May. I would describe the general mood as cautious optimism.
Which is about where I come out.
Irwin M. Stelzer is a contributing editor to THE WEEKLY STANDARD, director of economic policy studies at the Hudson Institute, and a columnist for the Sunday Times (London).
