The Ailing American Economy

As the Bush administration gears up to fight Iraq, it overlooks deep-rooted economic and social problems on the home front that represent “a clear and present danger to America’s national security”. The person on the street is more concerned about whether he or she will be employed tomorrow, and whether he would be able to earn enough to get out of debt prior to retirement, then with whether or not Iraq poses a military threat to the US.

In a statement issued prior to the meetings of the International Monetary Fund and the World Bank, US Treasury Secretary Paul O’Neill said, “I remain convinced that we are on a path to 3-3.5 percent real annual growth by the end of the year.” The reality is quite different. According to Professor David Levine of the University of California, Berkeley, a tech downturn coincided with a recession for the first time last year during President’s Bush tenure. In the spring of 2001, the dot-com bubble burst, dashing with it the prospects of many twenty something’s who had hoped to become instant millionaires. Then came the terrorist attacks of September 11, and the accompanying hike in spending on homeland security. The $10 trillion US economy went into a recession that many said would be a V-shaped recession, but is proving to be more like a W-shaped recession. The economy grew at the anemic rate of 1.3% in the second quarter of this year.

Scared by incessant talk about fighting a multi-year war over several continents with an invisible enemy, and facing joblessness, consumer confidence has began to erode. The University of Michigan’s index of consumer confidence has declined four months in a row and is at 86.1%, its lowest level since November 2001.

The stock market remains the best predictor of future economic growth. It is indeed in bad shape. The Dow Jones index is at a four-year low, in the high 7,000s. The technology heavy NASDAQ composite index is at a six-year low, in the low 1,000s. The broad based Standard & Poor’s 500 index is in the low 800s. If these trends persist, within the next two years, one can envision the Dow hitting 5,000; the NASDAQ dropping to 1,000; and the Standard & Poor’s dropping to 500.

The fall in stocks can be traced to a loss of investor confidence in corporate leadership and lower expectations of future earnings growth. Inflated balance sheets drove the market to record levels, and as news broke about one corporate scandal after another, involving giants such as Enron, WorldCom, Global Crossing, the market has beaten a retreat to more realistic valuations. Just when the analysts on Wall Street say the market has bottomed out, and this is a great time to buy, another scandal erupts, making us realize that we had not bottomed out.

The unemployment rate stands at 5.7%. It is much higher in the technology and telecoms sectors. One and a half million Americans have been unemployed for more than six months stands, the highest level since 1994. This number is up 80% compared to a year ago. Unemployment is taking a psychological toll on the unemployed, in addition to taking an economic toll. According to people who were interviewed by USA Today recently, it has led to frustration, alienation, personal and professional self-doubt among many middle-aged professionals. In some cases, it has become a cause of illness as well.

The upshot of economic stagnation is that the US poverty rate has gone up to 11.7%. With a population of 284 million, this amounts to 33 million Americans living below the poverty line. This number is very large, when compared with the incidence of poverty in other developed economies. It is large even in comparison to poverty levels in a low-income country such as Pakistan. Since the population of Pakistan is about half the population of the US, even with a high poverty rate of about 33%, there are only 46 million Pakistanis living below that country’s poverty line.

In order to ward off another recession, the Federal Reserve Bank has lowered short-term interest rates to 1.75% percent, there lowest level in more than forty years. The business community no longer views Fed Chairman Alan Greenspan as a maestro, and some wonder if his magic touch was an illusion.

The big question on every American’s mind is how will the coming war against Iraq affect the US economy. There appear to be more downside risks from this conflict than upside benefits. Even before the war has begun, the Bush administration is faced with the prospect of deficit financing to cover increased military spending. The democratic staff on the House Budget Committee estimates that a war with Iraq might cost $93 billion. This is just the direct cost of the war. It does not include the indirect costs of the war, which would be much higher. For example, costs would be incurred if soldiers develop some type of Gulf War II syndrome. More than a hundred thousand veterans of the Gulf War developed a painful syndrome comprising multiple symptoms, and they remain afflicted with the symptoms a decade later.

An even greater indirect cost of the war would be a US recession that may follow the war. Since the US has served as the engine of growth for the world economy, the recession may well be a global one. According to David Wyss, chief economist of Standard & Poor’s in New York, America’s past four recessions were triggered in varying degrees by events in the Middle East. Spikes in the price of oil caused the recessions during the mid seventies and early eighties. The Gulf war caused a major spike in oil prices, bringing on a recession that doomed George Herbert Bush’s chances for re-election. And last year’s recession can be traced in part to events originating in the Middle East.

The price of oil, at $30 a barrel, is up by 45% compared to last year. If this price hike is sustained, it could shave off 1.2% percentage points off the annual growth rate in the US, according to the IMF. The IMF is forecasting US economic growth at 2.6% for the year, down 0.8% from what it was forecasting in April.

According to Macroeconomic Advisers, a firm based in St. Louis, if war with Iraq causes oil prices to rise to $41.50 a barrel early next year, and the stock market falls by more than six percent, the US would slip into a recession, and the jobless rate would stay above six percent for the entire year.

The impact of a war on the travel industry would be unequivocally negative. American Airlines CEO, Don Carty, says that the war would be like having an “economic anvil dropped on the industry.”

The hawks in Washington disagree, and assert that the war would be short and decisive. Once a compliant regime is installed in Baghdad, it would begin pumping large volumes of oil, lowering oil prices and restoring American economic growth.

It is this optimism that gives credence to rumors that the war is being waged to gain access to Iraq’s oil resources, rather than to eliminate its weapons of mass destruction.

AHMAD FARUQUI, an economist, is a fellow with the American Institute of International Studies. He can be reached at faruqui@pacbell.net


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