| An Economy Going Nowhere, By Robert Kuttner
Stock-market bears may be right to lose faith.
What has been ailing the stock market?
Economic fundamentals haven't changed much in the past few months. The
dollar has been weak for more than a year, the worsening trade
imbalance is an old story, and oil prices have been high for months. So
why the big dip last week?
The immediate precipitating cause is weak corporate profits coupled
with ongoing worries about inflation that will likely cause the Federal
Reserve to keep raising interest rates. But the Fed has been clear for
many months that rates are going up, and a few bad earning reports do
not reflect the entire economy.
Stock markets, however, are notoriously vulnerable to herd instincts.
In the short run, what you think about the economy matters less than
what other traders think.
Recent market behavior looked like a classic tipping-point phenomenon:
A majority of investors conclude that other investors think the market
is heading south and decide to bail out. When there are more sellers
than buyers, stock prices fall. But what of the underlying economy? Are
the bad news bears right to be pessimistic? Unfortunately, yes.
The economy has been vulnerable for some time. The recovery has been
built on government borrowing at a rate that can't continue. More
troublesome, a rising share of this borrowing comes from overseas. That
puts pressure on the Fed to keep interest rates higher than it
otherwise might to keep the foreign lenders on board and keep the
dollar from sinking even lower.
Job creation and job quality have also been weakening. Although the
measured unemployment is officially a decent 5.2 percent, the fraction
of workers who have given up looking for jobs keeps rising, as does the
percentage of long-term unemployed. And worker pay is sagging.
Disposable income is affected not just by flat earnings but by rising
costs not fully captured by the inflation statistics. For instance,
people are paying a larger share of medical costs that aren't covered
by health plans. More adults are subsidizing grown children. Rising
interest rates sock home buyers as well as consumers who rely on credit
card and home equity loans. So those disappointing corporate profit
figures reflect one of the most basic of economic fundamentals:
Consumers with less money in their pockets don't rush out and buy
We last went through a serious bout of ''stagflation" in the late
1970s. That is a condition that isn't supposed to exist in economic
theory -- rising prices and rising unemployment at the same time. That
inflation was triggered by high oil prices. For several years, the
Federal Reserve's cure of very high interest rates worsened the
disease, since the high interest rates added to consumer financing
costs and also pummeled business. Inflation was eventually wrung out of
the economy, and the long boom of the 1990s and that era's high-flying
stock market were both built on steadily declining interest rates and
well-behaved oil prices.
No longer. And now there's a new factor: the arrival of China and India
as major players. On the one hand, consumers benefit from inexpensive
imported products. On the other hand, American workers have trouble
competing at the going wage, and earnings are battered down.
The latest wrinkle is that China and India are adding to worldwide
demand for raw materials -- oil, but also steel, timber, and all the
other ingredients of an advanced economy. The result is that oil prices
and other commodity prices are likely to stay high and even rising for
the foreseeable future. That adds to consumer costs, shows up in
inflation statistics, and prompts the Fed to hike interest rates.
But high commodity prices caused by rising global demand aren't the
classic inflation that represents our economy overheating. And it's not
cured by tight money. On the contrary, higher domestic interest rates
just depress the U.S. economy, but without significantly reducing
Asia's appetite for oil and other raw materials.
What to do? There is no easy cure. There are, however, two constructive
things the administration might pursue. First, it could stop running
the immense deficits that create so much dependence on foreign
borrowing. Second, it could get serious about energy self-sufficiency
built on new technologies. That would simultaneously create American
jobs and reduce dependence on imported oil.
The White House, of course, has no enthusiasm for either policy. What a
pity, both for the economy and for the administration's own political
Robert Kuttner is co-editor of The American Prospect. This column
originally appeared in The Boston Globe