The people who manage millions of U.S. investment dollars are frightened. For good reason. The so-called debt ceiling deal agreed to by the White House and the American Congress leaves the American government with no room to create jobs, or boost incomes. U.S. incomes are down by about 13 per cent since the 2007 recession began; the real U.S. unemployment rate (including part-time employees seeking full-time work, and discouraged workers) is 16.2 percent. American business depends on consumer spending, but consumers are broke, in debt, and jobs are hard to come by.
What adds to money manager fears and nervousness are concerns about the fragility of financial institutions on both sides of the Atlantic that lend money to stock market players, and underwrite government bond markets in the U.S. and Europe. French and German banks hold large amounts of Greek bonds, and those of other highly indebted EU nations. American financial institutions have written large amounts of Credit Default Swaps on those bonds, meaning that debt restructuring by Greece or other nations, triggers big losses for those U.S. hedge funds who have insured the debt.
To quell the nervousness, world financial institutions are calling for, and getting austerity programs from compliant governments in Europe (and elsewhere, including Canada). Reductions in public sector jobs, incomes, and public services are being imposed by European governments so that bond holders and credit insurers get paid. Workers in Greece, Spain and elsewhere understand they are being hosed, and are protesting.
The non-recovery of the U.S. economy -- overall GDP is no greater than it was four years ago -- requires a government-led growth strategy to change, and the debt ceiling agreement of Aug. 1-2 calls for cuts to spending. By Aug. 4 the stock market had figured out the problem was not the U.S. debt as had been widely claimed, but continued U.S. economic stagnation, and poor job creation prospects. Wall Street tanked that day. No growth in the U.S. economy equals little overall U.S. earnings growth, means a poor outlook for stock prices. The downgrade of American government debt by Standard and Poor's on Aug. 5 only added to market uncertainty.
The U.S. has three options for restarting the economy. The first is to take advantage of low interest rates, and develop a major public sector investment program, targeting infrastructure. Major borrowing and spending on domestic projects to make industry green, support public transit, create social housing, and contribute to recreation and cultural endeavours makes infinite sense, but has little chance of being approved by Congress. Replacing defence spending with domestic infrastructure investment should appeal to the White House, but U.S. involvement in three hot wars (Iraq, Afghanistan, and Libya) make serious defence cuts dependent on major foreign policy changes that are unlikely in any short time frame.
The second option is for the U.S. to promote inflation, so as to reduce the real cost of consumer debt, and of government debt charges. An inflation rate of over five percent for a few years would do the job. Eventually inflation would stabilize and increase falling housing prices, and improve the profit outlook for small business. The policy problem is that creating inflation requires an injection of new central bank credit, and the U.S. banking system is already awash in funds it is not lending because people are paying down debt, and not borrowing. Any new inject of Federal Reserve credit (a third round of Quantitative easing, the expected Q3) is unlikely to lead to much new spending.
The third option is the one the U.S. is following with mixed success. This is the deliberate strategy to devalue the U.S. dollar, transferring spending by Americans on overseas goods, and trips, to domestic spending on American goods and local vacations.
Currency devaluation is the most potent way for a trading nation to grow its domestic economy, but for the U.S. economy the foreign trade sector is not big enough for anything short of a major fall in the U.S. dollar to turn things around. Moreover, European debt problems are pushing the euro lower, so the U.S. is having trouble getting the dollar to fall at all. Indeed European money is flowing into dollar dominated assets because of fears over European defaults. Last week Japan intervened in currency markets to halt the rise in the Yen against the dollar. China has made a modest adjustment upwards of its currency to meet American demands, and Canada has made a major upward adjustment through hiking our central bank rate above the U.S. rate.
The overall effect of European austerity and the debt ceiling deal is to worsen the world economic outlook. Many of the major U.S. companies have separated themselves from the U.S. economy by operating globally. Some, like Apple, will continue to expand. Most are going to be hit by growing stagnation.
Worldwide, the best option is to promote a stronger public sector, through new borrowing. That means ignoring the noise about debts, and deficits. As the American example shows what matters is putting an end to stagnation, not cutting off economic options to promote job and income growth.
Duncan Cameron is the president of rabble.ca and writes weekly on politics and current affairs.
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