History also shows that the timing to the stimulus impact is not counted from the first easing (nor from the last), but from when the bulk of the easings have occurred.
Whilst the easings commenced in January last year, the Fed's rate was still at 5.75% at the end of March. Considering that its recent ceiling level was 6.75%, the stimulatory impact of the first 100bp was minimal (with the effect kicking into place earlier this year).
From late March 2001, however, the Fed further eased rates by 150bp through to end June. Then, from July 2001 onwards, the Fed again eased rates by 250bp. The stimulatory impact of the June quarter easings are, however, still filtering through the system, even on the basis of your own 12 -15 month time frame to impact.
As for where the Fed can do again in the future (if required), they still have 175bp of stimulus ahead of them. Currently, we are still in positive real interest rate territory, as opposed to the negative real interest rates of previous recessionary downturns.
However, could the Fed's policy of reducing interest rates be failing us this time round?
Of course it could. But, so too could any other policy out there (including the views held by some of history repeating itself).
As for deflation, we really do need to compare like with like.
Both in the 1930s, and again in the Japanese infused 1990s, the resepective Central Banks raised (not, lowered) rates. This, as much as anything (if not, more so) induced the deflationary impact characterised by both eras.
The greater risk to the US this time round, however, is not the failure (as you have perceived it) of the Fed to turn things around. Rather, it has more to do with the problems associated with structural imbalances occurring within the economy, whether from a CAD perspective, or from a business concentration perspective (ie: tech in calxifornia, etc).
As you have quite rightly pointed out, the US is running a substantial CAD which, if left entirely unchecked, could place the US recovery at risk. But, to blindly say that this will be the case risks distorting reality. The characteristics of the CAD, therefore, need to be examined to determine whether any of the deficit can be attributed to productive (ie: capital) goods being imported into the country. If so, then this should be positive to the future. If not, then of course there will be inherent risks in going forward on a large CAD.
More on this, in a moment.
As for the US Government being in deficit, this is also a potential distortion which needs to be better understood.
Of course, if you are talking about the entire US Goavernment sector (inclusive of the Social Scedurity deficit), then there is no hope for any of us.
But, if you are talking about the operational balance of the US Government's operations, then these are in surplus and have been since 1998 (with this year being the only possible excepion, given the level of 9-11 support that has been legislated for).
It is one thing to argue today's operational surplus and an acturial assessment of tomorrow's Social Security deficit represents a solid foundation for reforming the Social Security system going forward. It is entiely another thing to ignore altogether the structural nature of the US Budget and concentrate entirely on the Social Security system.
My key assessment for determining if a Government is performing effectively is whether or not its structural accounts are in balance. If so, well and good. If not, then depending upon the nature of what is occurring, then bad. In mid 2002, however, the US budget is structurally in near balance and going forward, this is positive to the US outlook.
As for the current state of the US economy, it is fair to say that the q2 routing in US stockmarket values will negatively impact US GDP to 50bp (0.5%). If the routing were to be maintained throughout h2,02, however, then the nagatively implied GDP impact could approximate 100 - 150bp (ie: 1.0 -1.5%). Offsetting this, to some extent, though has been the wealth creation effects in housing which, on average are more stimulatory to the economy than the corresponding financial impact of a declining sharemarket.
Commenting on the wealth impact of housing vs the equity markets, Merrill Lynch advised on 26 July 2002 that:
"$8.1 trillion of household equity wealth was wiped out from March 2000 through July 25, nearly 40% of that in June and July. Though gains from housing wealth neutralized up to the first $7 trillion of those equity losses, because the wealth effect from housing is more than double the wealth effect from stocks. But at this point , the loss of wealth is so large that it will reduce growth. The equity decline is likely to affect both consumer and business spending. Given their shrunken balance sheets, consumers will probably attempt to save more. That could reduce GDP growth by about half a percentage point during the next couple of quarters. A slowdown in capital spending growth is also likely, though that is harder to quantify.We assume that effect will also reduce GDP growth by about a half a percentage point during the second half....The equity slump has (also)raised the cost of capital. The IPO window is largely shut".
In part, because of the this, the Fed recently reduced its h2 GDP forecast from 3.5% to 3.0%, whilst Lehman Brothers reduced their GDP forecast to between 2.5 -3.0% (modal forecast of 2.6%) against a previous 3.0% forecast. Conversely, on Friday night, Merrill Lynch reduced their GDP outlook by100bp to 3.5% (previously, 4.5%) whilst leaving unchanged their 2003 GDP forecast of 4.0% (Lehman Brothers = modal forecast of 3.2% and an upper boundary of 4.6%).
As for the state of the economy, capital spending on equipment and software rose during q2 (+6.0%), representing the 1st such increase in 18+ months. For July, however, the markets will be looking to this figure being maintained, least of all companies being sppoked by the recent sharemarket action.
Also, going forward, the US benchmark revisions to GDP should be released later this week, but are likely to show a revised negative level of growth in q2,01 (meeting the technical criteria for characterisation of 2001 as a recession), whilst q4,01 growth is likely to show a weaker than previously argued growth outcome. In all, this is quite significant given that President Bush and his team were arguing back in September 2000 that growth in the US was weakening (whereas then Vice President Gore was arguing the opposite).
With household net worth in the US (as a percentage of after-tax income) now approximating 525% (well up on q4,01's 510% reading, but down on q1,02's reading of 540%, and well down on q4,00's reading of 620%), it can be argued that overall household net wealth in the US is now back to its levels of 1997/8 (ie: also approximating the levels of the 60s, and again of the late 80s). Clearly, the recent stockmarket routing will hurt, but it will not derail US recovery (only moderate some of its upturn).
The labour market outlook also continues to improve with jobless claims in the week ending 20 July 2002 falling to 362,000. This compares to 5 weeks ago, whn the jobless claims were running at 395,000. Previously, a sub-400,000 claiming rate was favourably compared to improving labour market conditions, and a growing payroll (ie: more jobs being created than those entering into the labour force).
With the capital goods market also starting to turn, and with the labour market outlook continuing to improve, productive capacity, and with inventory rebuilding helping to characterise h2,02, the economic outlook going forward remains positive, with: 1) industrial production rising @5.2% during h1,02; 2) capacity utilisation rebounding off its December 2001 lows of 74.4%, to reach 76.1% in June (still below its long-term average of 81.9%); and 3) factory inventory levels shrinking further (for the 17th month in succession).
Conversely, inventories of tech equipment continued to fall, along with overall tech sector activity. It is here where the US economy is hurting, and it remains here where the first sustained signs of a powerful upswing will occur. That said, the outlook for the tech sector appears brighter than it has been in the last 18 months, but is still well below the positive outlook reflected in results for 2000 and earlier.
The US downturn of 2001 can, therefore, be characterised more in terms of the following (than anything else): 1) the stalling in, and subsequent collapse in, tech sector sentiment; 2) the near total collapse in the Nasdaq (and especially, in the telco sector of the Nasdaq); and 3) 9-11.
Conversely, the US recovery of 2002 can be characterised in terms of the following: 1) the resilience of the US consumer in maintaining spending levels and consumer confidence; 2) active corporate management in managing within their existing capacity constraints, rather than through adopting a "build them and they will come" scenario play; 3) continuing productivity improvements in US manufacturing activity (contrasting very much the 1990s trend of outsourcing US manufacturing to overseas destinations); and 4) the continuing progression of the US economy towards a services based structural change (this, therefore, being one of the primary reasons why I am so concerned about the level of services inflation currently inherent in the US economy).
As for your more direct questions, any risk of a double-dip will be met in the following way:
1) FURTHER FED EASINGS:
So far, the Fed has eased rates down to 1.75%, the bulk of which occurred from May 2001, onwards. This means that the typical 12-15 month lag in securing the stimulatory effect of a Federal funds easing is still working its way through the system, and the bulk of the impact remains to work its way through in q3, and into q4. This time round, however, the real Fed funds rate has remained positive, rather than negative, as has been the case in previous recessionary environments. Going forward, the fed will do one of 2 things: a) keep rates on hold until into q1, 2003 (ie: the stimulatory impact of a further easing in rates of 50bp(+)); or b) (if things go from bad to worse) reduce rates by a ufrther 50 -75bp in 3 stages (ie: thus reducing real Fed rates to zero).
2) THE FISCAL APPROACH:
George Bush's tax cuts which were introduced post 9-11 were relatively modest in amount, and were paid out in several tranches. Going forward, the Federal Budget is structurally in balance, but once extended to the Social Security environment, is in deficit (as it would always be).
The Executive /Congress, however, could still do the following to stimulate the economy in these circumstances: a) run the Federal budget in structural deficit; b) reform Federal-State relations such that legislative impediments to doing business (ie: as between the states, and in individual counties) are removed /minimised; c) target aid packages to particular areas of depressed outlook (ie: the tech sector, California, and in the North-East manufacturing corridor); and d) target business reform (ie: through removing subsidies, artificial business stimulants, etc).
The Government also has room to still move on the household /family sector whilst controlling the corporate sector. This could well be a way for them to move forward.
The Government could also target business to repatriate their overseas manufacturing activity back to the US (ie: insourcing that which was outsourced in the 1990s) whilst offering NAFTA support and access to European or Asian companies wanting to set up business in the US.
3) EXTERNAL IMBALANCE:
This is of concern to the extent that the CAD is caused by consumption /changes in financial values. It is less of a concern, however, where an increasing portion of the CAD is accounted for in new capital goods spending. This is aleady being seen in the latest figures, and could easily be encouraged by the Government through a targeted depreciation /capital investment allowance to allow for the re-capitalisation of America's productive capacity.
4) OVERALL:
Confidence is one of the keys in any economy going forth. So to is trust, and integrity. The reforms that the US are now embraking upon are important strategically, and psychologially, for the future. The Bush administration has an ideal opportunity of re-building that trust and in shaping the future of a generation to come (through the corporate honesty reforms that are now being implemented).
If however, this fails, then yes, the US will be heading for a decline (perhaps, not a double dip, but who knows). But, Nickoo, now that I have done you the courtesy of answering your questions, I suggest that we each perhaps you could also do me the courtesy of answering my question (also, simple), below:
If the USA were to continue with its rate of recovery, what moderating activity should the Fed /Government introduce, to ensure the continuation of that recovery, considering the limitations of:
1) a sub-neutral Fed rates level which, in order to return to a neutral policy stance, would need to increase by 225bp(+);
2) without overheating the economy (ie: through the re-engagement of boomtime conditions);
3) without impacting against capacity constraints /shortages which would feed directly back into inflation; and
4) without re-igniting inflation whilst moving to moderate the unsustainably high level of services inflation.
Nickoo, I agree that we could debate this endlessly. But froma HC2 perspective, I believe that our colleagues are also benefitting from our ongoing exchanges on this (and, at least, are getting 2 different points of view - sort of like a balanced point of view).
