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Tice''s Marshall Auerback sees oil at $80
By Daniel Gross
The New York Times
Sunday, May 8, 2005
We seem to be living in apocalyptic times. On NBC's "Revelations,"
Bill Pullman and Natascha McElhone seek signs of the End of Days. In
the Senate, gray-haired eminences speak of the "nuclear option."
The doomsday theme is seeping into the normally circumspect world of
economics. In April, Arjun Murti, a veteran analyst at the
investment bank Goldman Sachs, warned that oil could "super-spike"
to $105 a barrel. And increasingly, economists are prophesying that
the American economy as a whole may be sailing into choppy waters.
Just look at the many obvious and worrisome portents. The government
each year spends much more than it brings in, and so the nation has
a large budget deficit ($412 billion in fiscal 2004, and growing).
Americans also import far more goods than they export, and so the
nation has record trade and current account deficits.
As consumers, Americans personally spend significantly more than
they earn. Worse, some imbalances are eerily reminiscent of
conditions that helped touch off recent economic crises: Mexico in
1994, Asia in 1997, Russia in 1998 and Argentina in 2002. Throw in
rising interest rates, warnings of a housing bubble and the
potential for higher inflation and slower growth (a k a
stagflation) - and you can understand why some economic analysts may
be plumbing the New Testament for inspiration.
The forces propelling and buffeting the economy are like a series of
interrelated and interconnected weather systems. Could they be
setting the conditions for a perfect storm - a swift series of
disturbances that causes lasting damage? If so, what would it look
"There's a pattern that is familiar from so many other countries
that have gotten into debt problems," said Jeffrey A. Frankel, an
economist at Harvard's Kennedy School of Government. "A simultaneous
rise in interest rates, fall in securities prices and depreciation
of the currency."
Of course, economists, always armed with bandoliers of caveats, are
quick to warn that the economy is relatively healthy. Job growth
numbers released on Friday were strong, with 274,00 new jobs created
And they warn against drawing parallels too sharply between the
mighty United States and emerging markets. The dollar remains the
world's reserve currency, and the United States is a global military
and political hegemon. And the nation has been able to borrow huge
amounts for years without suffering a crisis.
That said, how might a perfect storm be created?
It would likely gather overseas, and wouldn't necessarily take the
form of a terrorist strike or oil shock. The United States finances
its spendthrift ways by selling dollars and dollar-denominated
securities (like Treasury bills) to foreign creditors, mostly to
central banks in Asia. To sustain growth, the United States needs
foreign creditors to continue to add to their piles every day.
Any signs to the contrary are worrisome. In February, when the
Korean government suggested that the Bank of Korea might diversify
its foreign exchange holdings, "this seemingly innocuous statement
set off a small panic in our stocks and bond markets," said James
Grant, editor of Grant's Interest Rate Observer.
If the Bank of China, which has been accumulating dollars at the
rate of $200 billion a year, decides to cut back on new purchases,
either to diversify or to let its currency appreciate, the United
States would quickly have to offer sharply higher interest rates to
retain existing investors and entice new ones. Nouriel Roubini, an
economics professor at New York University's Stern School of
Business, estimates that if China cut its rate of accumulation by
half, long-term interest rates in the United States could rise by
200 basis points over a few months and the value of the dollar would
Such a rising tide -- the yield on the 10-year bond shooting from
4.25 to 6.25, the average 30-year mortgage rising from 6 percent to
8 percent -- would mean instantly higher borrowing costs for the
government, businesses, and consumers. It would drench Wall Street,
soaking the stocks of giant interest-rate-sensitive blue chips like
Citigroup and making life difficult for speculative, debt-ridden
companies. Some highly leveraged hedge funds or investment banks
caught on the wrong side of trades would incur significant losses.
The United States weathered a sharp decline in the stock market just
a few years ago, in large part because of the housing market's
strength. But a sharp rise in interest rates would literally hit
home. For new home buyers, or for people with adjustable rate
mortgages, 200 extra basis points of interest on a $400,000 mortgage
would represent $8,000 a year in extra payments. If mortgage rates
were to rise sharply, housing prices would level off and perhaps do
the unthinkable: fall.
Suddenly, the mechanisms that have allowed consumers to keep the
economy afloat -- the ability to realize profits from selling homes,
to refinance mortgages at lower rates, and to borrow cheaply against
home equity -- would be broken. In the absence of sharply rising
wages, that $8,000 in extra interest would be $8,000 less to spend
at Home Depot, or at the Cheesecake Factory, or at Disney World.
"Personal expenditures in the past 15 months have been largely
financed by borrowing," said Wynne Godley, a Cambridge University
economist who is affiliated with the Levy Institute at Bard
College. "And even a reduction in the pace of debt creation will
force people to start spending less, on a big scale."
If the dollar weakens and consumption falls, the trade and current
account deficits would start to narrow. But the United States
economy would slow and, perhaps, even shrink.
"The result would not be a full-blown financial crisis most likely,
but it would still be a major recession," said Barry Eichengreen, a
professor of economics and political science at the University of
California at Berkeley.
What would create the full-blown crisis?
When the slowdown starts to radiate across the globe, said Catherine
L. Mann, senior fellow at the Washington-based Institute for
For years, the American consumer has been the engine of global
growth, by gobbling up the output of oil wells in Saudi Arabia and
factories from Mexico to China. "The slowdown in consumer spending
is going to have a negative influence on the global economy through
reduced international trade," Ms. Mann said.
What's more, a recovery would be comparatively slow in coming. When
the global economy came to a screeching, synchronous halt in 2001,
the United States led much of the world back to growth because the
federal government went on a stimulus binge for several years:
Congress significantly increased government spending while cutting
taxes, and the Federal Reserve slashed interest rates to historic
lows, and held them there.
But in the perfect economic storm, none of these three powerful
levers would be readily available. Today's deep budget deficits make
both significant tax cuts and spending increases unlikely. And
rising interest rates would make it difficult, if not impossible,
for the Federal Reserve to reduce the cost of borrowing.
It sure sounds alarming. But as the clouds gather and the wind
stiffens, we sail onward, with no apparent adjustment in course,
full steam ahead.
Why aren't we rushing to take evasive action? Why is Congress adding
new spending while it passes new tax cuts? Why aren't financial
institutions encouraging Americans to pay down their debt rather
take on more?
A lot of it has to do with timing. While many economists are willing
to imagine in detail what a perfect storm would look like, virtually
none will forecast precisely when -- or if -- it will start. And so
it remains a vague and distant possibility.
Besides, adds Jeffrey Frankel, "some of us have been warning of this
hard-landing scenario for more than 20 years."
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