The “Near Strengths” and “Far Worries” of the U.S. Economy

Even though inspiring unanticipated recovery has appeared recently in the U.S. economy, many thick layers of contradictions restricting full-blown recovery have yet to be resolved.

The most recent statistics, mostly optimistic, indicate that the recovery rate of the U.S. economy will increase in 2011. On Feb. 2, 2011, the U.S. Institute for Supply Management announced that the manufacturing industry index was 60.6, surpassing the growth rate of the past seven years.

Since the fourth quarter of 2010, the U.S. economy has shown indications that recovery is speeding up, with GDP growth at 3.2 percent (while the growth rate for the third quarter and second quarter was 2.6 percent and 1.7 percent, respectively), the highest since the economic decline in late 2007.

“Near strengths”: statistics are making people happy

Fourth quarter statistics indicate a 4.4 percent increase in consumer spending during the fourth quarter, the highest it’s been since the beginning of 2006 and two times the average increase in the first three quarters of 2010.

At the same time, there appeared a trade surplus in the fourth quarter, and net exports contributed 3.55 percent of growth to GDP. In December, the amount of U.S. imports and exports reached a two-year high, with imports increasing 2.6 percent and exports increasing 1.8 percent. The year’s exports increased 16.6 percent, meeting the initial goals of the Obama administration, which called for maintaining an export growth rate of 15 percent by 2015.

Under the backdrop of an improving macroeconomy, domestic demand has received a boost. Spending on durable goods, such as for automobiles and furniture, has increased 21.6 percent, spending on non-durable goods, including food and clothing, has increased 5.0 percent, and spending for services such as transportation and health care has increased 1.7 percent. While the economy was recovering, the rate of inflation stayed relatively low. In the fourth quarter, the core consumer price index, converted to a yearly rate, increased 0.4 percent, lower than the third quarter growth rate of 0.5 percent.

President Obama’s recent State of the Union address, as well as other public government activities, indicated that the U.S. government will take additional measures to increase economic growth and increase America’s competitiveness. Improving the nation’s infrastructure is an important measure of the policy, but high speed rail and high speed wireless internet access takes top priority.

The White House announced that it will invest $53 billion towards high speed rail in the next six years, increasing the proportion of high speed rail to 80 percent within 25 years. According to this plan, the U.S. Department of Transportation will pick new “corridors” and encourage citizens to take the train. An additional measure is to invest $13.5 billion to construct a passenger rail network between New Jersey and New York City.

At the same time, the White House announced plans to increase nationwide wireless coverage to 98 percent, with plans to raise $30 billion in the next 10 years towards this project and using public security networks’ nationwide broadband network to support the infrastructure necessary to bring high speed wireless to rural areas.

Other than the “two high” plan of high speed rail and high speed wireless, Obama also brought up restoring or building new highways, bridges and airports in his State of the Union address, along with the plan to form “infrastructure construction banks” in order to reform the infrastructure construction financing mechanism.

The Obama administration’s short-term goal is to use the increase in infrastructure investment create employment and to provide a “quick fix” for domestic demand. The long-term goal is to use the push for investment in infrastructure as the cornerstone for increasing U.S. competitiveness.

“Far worries”: recovery is mired in a vicious circle

Even though inspiring unanticipated recovery has appeared recently in the U.S. economy, many thick layers of contradictions restricting full-blown recovery have yet to be resolved. Many are worried about the future direction of the U.S. economy.

*Substantial federal government debt. U.S. Secretary of the Treasury Geithner said on Jan. 6 that the U.S. deficit is expected to touch the $14.29 trillion debt limit by March 31, and “very possibly” reach the limit by May 16, setting a new high. This implies that for each dollar that the federal government spends, 40 cents come from borrowed funds and that on average, each American owes $45,300.

As for the question of whether or not to raise the debt limit, President Obama faces two difficult choices. First, if the limit is not raised, then there will be violations of contract and the U.S. would not be able to pay back its debt on time, creating a “financial catastrophe,” causing debt holders to lose trust and affecting its credit rating. Yet, raising the debt limit would be opposed by the Republican-controlled House of Representatives. Even if the U.S. government raises the limit directly or indirectly, such as through borrowing from the federal retirement fund, delaying payments to government employees and the Social Security Trust Fund or even renting out government property, the result is nothing more than taking on new debt to pay off old debt or delay the payment period and does not solve the root of the problem.

With the pressure of the serious deficit problem, Obama will have a hard time winning approval for his ambitious plans to invest in infrastructure from Congress. In fact, Congress is requiring federal budget cuts of $2.5 trillion within 10 years, which includes large cuts in the transportation budget. Whether or not the Obama administration’s policy of stimulating the economy through infrastructure investment plans, such as the “two high” plan, will be successfully implemented is still an unknown.

*Local “financial bankruptcies.” Unlike the federal government, under American law, state governments are not allowed to have deficits. When deficits appear in state governments, they will not receive financial aid from the federal government. Whether or not the Democratic or Republican parties choose to raise the debt limit will not affect state governments.

Many states in the United States are facing problems of financial budget deficits, but they have to be “self-reliant” or “shut down.” To avoid the bad luck of having to “shut down,” the states have, one by one, taken measures to control financial resources, each having its own trick up its sleeve in a race to get to the other side.

When state governments cut budget deficits, they can only “operate” on welfare, including cutting expenses on programs such as social security, health care, Medicaid and food stamps. For example, California faces a $25.4 billion budget gap. California Governor Brown required his citizens to choose between prolonging the period of tax increases or making dramatic cuts in the budget, as well as suggesting cuts in health insurance services, higher education expenses and senior residential services, and prolonging taxes such as income and sales tax for five more years. New Jersey has already stopped paying out $3.1 billion in retirement funds; the Illinois general assembly has already voted to increase income taxes from three percent to five percent. Whether it’s cutting budgets or raising taxes, the result is an inevitable restraint on domestic demand, restricting U.S. economic recovery.

*The negative effects of implementing quantitative easing monetary policy. After Obama took office, he introduced a “large scale economic stimulation plan” (two implementations of quantitative easing). The first quantitative easing monetary policy implementation did not solve American banks’ bad debt problem. In November 2010, $600 billion was added in a second implementation of the policy, a much bolder move than any that were promised during the election.

Because the effects of the first implementation of quantitative easing were not ideal, the U.S. did not reduce national debt to speed things up, but rather increased it. The second implementation was geared toward buying long-term national debt. The latter means that the Fed will buy $600 billion to $900 billion worth of debt, which is equal to an average of $75 billion of national long-term debt per month. The Fed would exchange maturing mortgage loans from its asset portfolio for debt, exchanging $35 billion in bonds per month. The Treasury will issue $114 billion of new national debt per month, of which the Fed will buy $110 billion.

A policy of quantitative easing has the following benefits for the U.S.: pushing down the cost of capital and lowering the cost of borrowing, pushing up stock market prices by using American families’ “collected cash” to increase consumer spending; a lower cost of capital would increase American corporations’ investments, stimulating the growth of the economy and expanding employment; a depreciated dollar would lower the price of exported goods, increasing exports; a depreciated dollar would lower the cost of paying off debt; American multinational corporations can use the benefits of the liquidity of the easing, enjoying developing market-based economies’ relatively high economic success, the profits of which would flow back directly to the parent company in the U.S.

At the same time, the monetary policy of quantitative easing contains high risk. The Fed buying massive amounts of national debt will create a large inflationary effect, and once financial markets experience significant inflation, there is the possibility that long-term interest rates will be pushed up, causing the Fed’s plan of buying back national debt to have the opposite affect than was intended. Currently, the U.S. has not yet shed the shadow of the financial crisis, the unemployment rate is 9.6 percent, the number of foreclosed homes in the real estate market has reached 140 million, and the construction industry has shrunk 28 percent. If the above problem cannot be resolved, U.S. inflation will be hard to control. The Fed’s success or failure needs to be judged in a second round.

Quantitative easing increases capital outflow, inundating global liquidity. On one hand, the newly added liquidity will not immediately enter the real economy and become assets, but enter the financial system and overseas, inducing the creation of a new asset bubble, causing commodity prices to increase and transforming into developing countries’ imported inflation. On the other hand, there is an ever-widening chasm between each country’s economic systems. On one side is the liquidity created through deflation; on the other side are rising economies’ economic systems and commodity-producing countries overproducing because of increased utility and causing inflation.

*High unemployment rate. One of the biggest worries facing the U.S. economy is that the unemployment rate is high without signs of falling. The Congressional Budget Office predicts that the official 2011 unemployment rate will remain above 9 percent, with unofficial real unemployment at 16 percent. The unemployment rate will remain at a high of 8 percent until 2013.

To solve the financial and economic crisis, governments around the world, with the U.S. in the lead, have rolled out economy-stimulating market rescue plans one after another. These large market rescue funds have largely been used to bail out bank systems on the verge of bankruptcy, not toward the real economy (or very little has been used for the real economy). Banks are the central nerve of the people’s economy and are a highly interconnected “department” of capital. These market rescue funds are only temporary solutions for the bank system’s conflicting lack of capital and do not really solve any issues in the real economy, a symptom of which is a high unemployment rate that refuses to drop, giving rise to a duality where the economy is recovering but the unemployment rate remains high. It can be said that an economic recovery where there is high unemployment is an abnormal recovery, and an economic recovery without sufficient employment cannot be maintained.

A high unemployment rate signifies a withering real economy. The real economy has not fully recovered, which will provide an obstacle for the recovery of the worldwide economy as well as limit the degree and level of an economic bounce-back. If this is not handled correctly, it could even lead to a second dip, causing the premature death of a previously recovering economy.

The immediate consequence of high unemployment is insufficient domestic demand, which in turn exacerbates the problems in the real economy, even going so far as causing corporations to go bankrupt. Causing corporations to bankruptcy causes bad debt to increase, discounting the effect of the U.S. government’s market rescue plan and preventing it from carrying out its role as the central nerve of the economy.

High rates of unemployment, insufficient domestic demand, a withering real economy, a shrinking banking and financial industry, deflation, a declining economy (short term recovery), a climbing unemployment rate — the U.S. economy is mired in a vicious cycle. From another direction, the policy of quantitative easing causes it to be stuck in another vicious cycle: Investing in market rescue funds, economic recovery, real estate market and stock market bubble, the price of assets rising, inflation, the standard of living lowering (disguised as unemployment).

In facing high rates of unemployment, the United States has used methods that violate the basic principles of the market against other countries, such as abusing anti-dumping and reverse subsidies to prevent other countries’ goods from entering its markets. Another example is that the market rescue funds can only be used to buy American goods. These protectionist actions cannot solve the problem of unemployment, but rather worsen the issue and, at the same time, provoke other countries’ retaliation. The start of a trade war would not help in moving the global economy from a track of economic decline to that of recovery and easing the unemployment situation.

The author is the president of the American Economics Research Center in the World Economics and Politics Research Center of the Chinese Academy of Social Sciences.