The Financial Times, April 21, 2003
The first President George Bush won the first Gulf War. A year later helost the presidency because the economy was in the tank. Will the second GeorgeBush suffer the same fate? There is one big difference that should work in hisfavour. The first Bush's recession started after the first Gulf War, while thesecond Bush's recession started before the second Gulf War. But the nature ofthis recession may remove the advantage.
With recessions, timing usually makes all the difference. Recessionstypically last about a year and a half. That is why presidents like to havethem early in their first term. They get it over with, so by the timere-election day rolls around economic indicators are pointing upwards. If therecession that began in 2001 followed the typical pattern, it would be over bynow, and President George W. Bush would be in good shape for re-election in 19months' time.
What makes the White House nervous is that the current recession is farfrom being over. Indeed, the US economy continues to lose jobs at a remarkablerate. The last two monthly job reports, for February and March, show a combinedloss of almost half a million jobs. So far, this recession has spawned thelongest continuous decline in jobs in half a century.
From the beginning, the 2001 recession broke the rules. Most USrecessionsstart when the Federal Reserve Board raises interest rates to cool anoverheated economy. Then consumers put a brake on spending because they cannotafford to borrow more money. This is what happened to the first President Bush.Alan Greenspan and company in effect did him in. But the Fed did not start the2001 recession. This one began when corporations stopped buying capital goodsand the technology bubble burst. In fact, Greenspan and company have cutinterest rates 12 times, to their lowest level in decades. Yet this curiousrecession goes on.
Even though corporations still have not resumed spending, Americanconsumers have kept buying. But there is a limit to how much consumers canspend when their jobs are disappearing and their pay cheques are under stress.The White House's worry is that consumers are now deep in debt. They werealready in a hole when the recession started, but the hole is now so deep thatmany cannot climb out.
Low interest rates have made it easy for many cash-strapped consumers toborrow against their homes. Last year, American homeowners raised $130bnthrough home-equity loans, nearly double the amount they borrowed in 2001. Sofar this year, the home-equity borrowing binge continues. Homeowners are usingthe cash to buy all sorts of things they otherwise would not be able to afford- appliances, home repairs, new or used cars. But mainly they are using it topay down mounting credit-card debt. That is smart. Interest rates onhome-equity loans are only about half those on credit-card debt, andhome-equity interest payments can be deducted from income taxes while intereston credit-card debt cannot.
As long as home values keep rising, borrowers are protected against acashcrunch. If they cannot make a payment, they can always take out another loanagainst the rising value of their home. But here is the catch. When interestrates start heading up again, housing values will stop rising and may even godown. Mortgages will become more expensive, which means fewer people in themarket to buy a home. So many new homes are now being built, that some housingmarkets are already facing a glut. Home prices are now softening in Oklahoma,North Carolina, Indiana, Ohio, and the state of Washington.
Why would interest rates rise? Because America as a whole is deep indebt.The federal budget will have a deficit of more than $300bn this year andanother $300bn next year. Over the next 10 years, the federal deficit isexpected to top $1,500bn. If the president's proposed $730bn tax cut isenacted, the sum will be larger still. Huge deficits push up long-term interestrates because lenders naturally assume that they will lead to inflation.
Meanwhile, the US continues to import far more than it exports, resultingin a widening trade gap that has been financed by foreigners lending us moneyand buying up US assets. Total foreign debt now totals about $3,000bn. So it isno surprise that the dollar has been weakening relative to foreign currencies.A weaker dollar also fuels inflation, because everything the US buys fromabroad costs more. And inflation fuels rising interest rates.
So what happens to an economy with continuing job losses, high consumerdebt, and a weakening dollar? It does not rebound any time soon. Indeed, thereis a significant possibility that it will not do so before the nextpresidential election in November 2004.
The first President Bush won the first Gulf War but lost the subsequentelection because, by election day, the first thing on the minds of mostAmericans was the economy, stupid. Political strategists for George W. Bushhave reason to worry that history may repeat itself.
