Dr Bharat Jhunjhunwala
The United States’ Federal Reserve Bank has the same role as our Reserve Bank of India. The Fed had implemented the stimulus package soon after crisis struck in 2008. Interest rates were lowered to near zero. It became attractive for consumers to borrow and spend. This has led to an increase in demand for goods in the market. Lower interest rates also lowered the cost of production for existing US companies. This helped them sell goods in the global marketplace. This increase in domestic- and export demand has led to some increase in jobs. Thus it was widely anticipated that the economy would soon be established firmly on a growth track.
The US crisis has had a beneficial effect for us as well. Lower interest rates have made it profitable for US companies to borrow in America and invest abroad where interest rates are higher. Thus the stimulus money has reached our shores in large measure. This inflow of foreign investment helped maintain a high price of the rupee vis-à-vis the dollar from 2008 to 2012.
US Fed Chairman Ben Bernanke had previously indicated that the Fed may taper off its cheap lending policy in view of the positive indicators. But the Fed backtracked on this and decided to continue with the stimulus package. The Fed has noted two opposite indicators. One, that the economy is growing. At the same time the Fed has lowered the expectation of growth rate for the current year from 2.3 to 1.0 percent.
There are two possibilities here. One possibility is that the US recovery is genuine and the economy will continue to bounce after withdrawal of the stimulus just as a sick man recovers after a bout of surgery. Another possibility is that the recovery is fake and the US economy will relapse into a crisis after the stimulus is withdrawn just as an athlete loses his speed after the steroids wean off. Withdrawal of the stimulus will lead to an increase in interest rates. The US consumers may again clam up. US companies may find their borrowing costs increasing and they may be priced out of the global market.
Question is whether the recovery will sustain or it will be merely a fleeting moment?
My assessment is that the recovery will not sustain because it is wholly built on increasing levels of debt. A shopkeeper may take a loan and build an excellent showroom and employ ten persons to manage it. This would lead to generation of employment. But these jobs will sustain only if sales take place. The shopkeeper would be burdened with debt and may go bankrupt if the goods stocked in the shop are not competitive. That is the situation of America today. The debt burden of the US Federal Government has increased by USD 5.3 trillion between 2008 and 2012. Yet more debt has been accumulated by state governments and the public. The total increase in debt may be more than USD 10 trillion. The increase in GDP, however, has been a paltry 1.5 trillion. In other words mere 15 cents of income is being generated form a dollar of debt. This is because only a small part of debt has been used for productive investments that would generate additional incomes and help repay the debt. The debt has been used to finance current expenditures of the US Government. Public investment in research, education and infrastructure has declined. This indicates that the present recovery in the job market is based not on innate strength of the economy but on borrowings.
I suspect that the US economy will soon face another crisis. Withdrawal of the stimulus will be followed by reduced consumption by the consumers. Unfortunately, analysts are wholly focused on the increase in jobs taking place at the moment and they are not looking at the huge increase in debt that is taking place along with. Note that international rating agencies have not revised their ratings of the US Sovereign Bonds upwards despite the favourable job data. They are taking increasing levels of debt into account, it seems. The reported increase in jobs is suspect too. Bernanke has admitted that the reduction in unemployment rate is not due to generation of new jobs but because many have stopped looking for jobs. A news report says that many of the jobs created this year have been part-time positions in industries with generally low pay, such as hotels, retailers and restaurants. Businesses have also reduced spending on heavy machinery and other long-lasting factory goods. The reported increase in jobs should be taken with a pinch of salt, therefore.
A survey of 43 economists estimated that the growth rate in 2014 would climb to three percent from one to two percent presently. This assessment too is mainly based on the increase in jobs seen at present and I am not convinced of this. My assessment is that the US economy will relapse into a recession after the momentum of the stimulus package wears off.
The present recovery in the US economy is the lull before the storm. It is wholly based on a huge increase in debt. A businessman can borrow, sell goods at a discount, increase the job count and also turnover, but this cannot sustain unless he can continue to sell at normal prices after the discount regime comes to an end. I doubt if the US can sustain the present jobs and exports after the stimulus package is tapered off. The basic competitive position of US companies in the world markets is not good. However, cheap domestic interest rates have made it possible for them to stand in the global marketplace. End of the stimulus will put an end to this and the true situation will come out roaring. It may take about two years for this to come out the open though. The US economy will be faced with a deeper crisis then.
Our economy is deeply affected by the happenings in the US. We have got large amounts of foreign investments between 2008 and 2012 because of the low interest rates prevailing in that country. End of the stimulus will lead to increase in interest rates in the US and lead to outflow of foreign investment from India and other emerging economies as seen in the last two months. But we should not get overly worried about this. Soon the US will again be staring at a deeper crisis. Foreign investors will again make a beeline towards emerging markets then. We must improve our domestic governance and ready ourselves to receive that flow which may otherwise go to better governed emerging countries like South Africa and Brazil.
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