A Hard Landing for the United States

“Mr. Greenspan likes to claim that, thanks to his brilliant policy, the U.S. economy experienced its mildest recession during the whole postwar period in 2001. If this was an achievement, it was more than offset, however, by the following unusually sluggish recovery.”

Dr Kurt Richebächer

According to Fed Chairman Alan Greenspan, the U.S. economy’s slowdown in the second quarter was just a “soft patch” caused by the sharp rise of the oil price and “geopolitical” uncertainties. After all, the economy’s growth is built on excellent fundamentals. That the bullish consensus in the United States readily swallowed this message is hardly astonishing. But it was also fully shared by the Organization for Economic Cooperation and Development and the International Monetary Fund. Both are forecasting continuously robust U.S. economic growth.

At issue remains the familiar question of whether or not the prodigious fiscal and monetary stimuli of the past have been successful in launching a protracted, self-sustaining economic recovery in the United States.

What, exactly, does “self-sustaining” expansion mean? We would say it describes two key conditions: first, the complete absence of any artificial monetary and fiscal stimuli; and second, a change in the economy’s pattern of growth from debt and bubble-driven, to employment-and income-driven.

Both conditions are not at all fulfilled. Tax cuts have ended. Individual tax refunds heavily bolstered consumer incomes during 2004’s first half. Although the Fed is gradually raising its federal funds rate, it remains artificially low. Investors have been stunned in recent months by the quick, sharp drop in 10-year Treasury yields from 4.9% to barely 4%.

Business spending on high-tech investment has picked up, but there is reason to assume that investment projects have been pulled forward to benefit from the 50% accelerated depreciation, expiring at year-end and to be followed again by new weakness.

Mr. Greenspan likes to claim that, thanks to his brilliant policy, the U.S. economy experienced its mildest recession during the whole postwar period in 2001. If this was an achievement, it was more than offset, however, by the following unusually sluggish recovery.

It was, in fact, the U.S. economy’s weakest recovery by far in the whole postwar period, compared to the growth rates of earlier postwar recoveries. Worst of all, though, was its badly skewed composition. In the past, personal consumption has on average accounted for 67% of real GDP growth. This time, its share was 109% of GDP growth. The other unusually large contributor was government spending, with a share of 33%.

It has, meanwhile, been recognized that the economy’s transition from subpar growth toward self-sustaining expansion requires strong capital spending and hiring by businesses. The consensus is convinced that both are definitely on the way. A supposedly splendid corporate profit performance and highly liquid corporate balance sheets are the main arguments.

Careful scrutiny of the relevant facts leads us to a radically opposite assessment. First of all, as we shall explain in detail, the trumpeted profit boom of the past two to three years had the most miserable quality; and second, corporate balance sheets have hardly improved, if not worsened. Continuous strong debt growth compares with record low net fixed investment.

In 2000, capital spending exceeded the internal cash flow – accruing from depreciation allowances and retained earnings – by $308.9 billion. During 2003, the sector ran a financial surplus of $56.5 billion.

The consensus has hailed this development in corporate finance. They fail to see that this liquefaction of corporate balance sheets had a highly negative cause, owing overwhelmingly to the circumstance that business fixed investment spending has increasingly fallen short of current depreciations. To wit, it reflects a shrinking productive capital stock.

Respected International Banker, Economist and Author

Dr. Kurt Richebächer’s articles appear regularly inThe Wall Street Journal, Barron’s, the US edition of The Fleet Street Letter and other respected financial publications. France’s Le Figaro magazine did a feature story on him as ‘the man who predicted the Asian crisis.’