Just when things couldn’t get any worse, they did. The Federal Reserve Board’s economists revised their growth estimate down, and their inflation forecast up. The dreaded word “stagflation” has begun to make its appearance, reminding those Wall Street analysts old enough to remember that in the 1970s the economy experienced 15 percent inflation, 9 percent unemployment and three recessions.
Those who want to update their financial vocabularies further should also take note of the new buzz word, “contagion,” used to describe the fact that problems in the subprime market are spreading to other parts of the closely interlinked credit market, such as credit cards and non-subprime mortgages.
Add “decoupling” to your lexicon and you will be au courant: Analysts who confidently predicted that America’s problems would not spread, are now less certain that the U.S. economy is “decoupled” from the rest of the world. A bank has gone bust in Britain, and Europe’s economists are predicting a slowdown.
Now for the bad news:
» Consumer confidence is at its lowest level since the early 1990s.
» “There is not much doubt in my mind that the U.S. economy is now in recession,” well-regarded Goldman Sachs economist Jan Hatzius is telling the firm’s clients.
» The jobs market is weakening, and may even be contracting. Which is bad news indeed since “Payrolls don’t just edge lower in a recession…. They drop like a stone,” reports Business Week economist James Cooper.
» The Fed’s minutes report that “recent data … indicated that consumer spending had decelerated considerably.”
Now for the really bad news: Last week oil prices pierced the psychologically significant $100-per-barrel level for the first time, not counting one trade on Jan. 2 by a trader eager to become a footnote to history.
This caught a lot of speculators short, because they expected prices to move in the other direction, and settle in the high $80s. After all, demand for gasoline in the United States is weakening, and worldwide demand for oil is now expected to grow more slowly than was previously thought. Meanwhile, inventories of crude oil are on the rise.
Yet prices are rising. One reason is that many observers expect the checks to be issued as part of the Bush stimulus package to reach consumers by early summer, just in time to offset any pressure we might feel to stay home rather than take to the road during the driving season.
Even more important are developments on the supply side. Markets were temporarily rattled when Venezuelan President Hugo Chavez threatened to cut off oil supplies to us, despite the facts that America has about the only refineries capable of using his country’s very low-grade crude oil, and that he is desperate for funds. But production in Venezuela continues to decline, as much-needed investment is diverted to Chavez’s welfare projects. Also, some 10 percent of Nigeria’s oil production has been cut off by rebels.
Most important of all, the Organization of Petroleum Exporting Countries, which accounts for about 40 percent of world output, refuses to lift its production ceiling, despite personal pleas to the Saudis from President Bush. The Saudis seem to have adopted the attitude, “A friend in need is a pest.” OPEC fears that an economic slowdown will cut into demand, and that the dollar will fall further, reducing the purchasing power its cartel members receive in return for their oil.
The longer term problem stems from the refusal of many nations to open their oil fields to exploration and development by Western firms. With high prices producing as much money as even the producing countries can reasonably spend and invest, they have no compelling need to bring new supplies to market.
Besides, if they want to increase the flow of cash, they can always insist on renegotiating the deals signed with Western countries, giving credence to the observation that a contract with an oil producing country is the first round in a negotiation.
At last, the good news. Last week, a leading investment banker told me that his firm’s clients are making money, have good cash flows and are earning about 20 percent returns on their businesses. Businessmen I talk with, although concerned about what might lurk just around the corner, report healthy sales and satisfactory profits. I can’t help feeling that the health of the firms on the sharp edge of the economy tells us more about our future than the problems of accident-prone bankers and investors who forgot how to price risk.
Examiner columnist Irwin Stelzer is a senior fellow and director of The Hudson’s Institute’s Center for Economic Policy.
