The world's growth engine is clearly sputtering
www.nationalpost.com Sherry Cooper Financial Post Friday, March 14, 2003
Does anyone really believe that the weapons inspections in Iraq are working and that the United States has already won, as Mr. Chrétien suggested last weekend? While we can reasonably debate the necessity of going to war, it is difficult to argue that Iraq is in compliance with Resolution 1441, requiring full and unconditional disarmament. The United States and the U.K. cannot indefinitely keep a 200,000-plus armed force on the doorstep of Iraq. And without that force, the weapons inspectors would be rendered impotent. As the diplomatic dance continues, the global economy has already paid an enormous price, and that price is now rising rapidly.
For more than a decade, the United States has provided the growth engine for the rest of the world. That engine is now clearly sputtering. While the American economy appeared to be reviving last summer, the resuscitation was cut short by the surge in energy prices and the shocks to business and consumer confidence. The rise in energy prices -- oil, natural gas, heating oil and gasoline -- has imposed a heavy tax on both households and businesses. Those who have recently paid a heating bill or filled up a gas tank know that discretionary income is down sharply. More than the fear of Middle East oil disruption has contributed to the surge in prices. It has been exacerbated by the unusually frigid winter weather. A strike in Venezuela, the fifth largest exporter of oil, has hobbled output. Refiners in the United States, the largest consuming nation, have whittled inventories to record lows in an effort to cut costs, and the shutdown of nuclear power plants in Japan has triggered large imports of extra oil for electricity there. Compound this with reduced conservation efforts, as Americans and Canadians have fallen in love with gas-guzzling SUVs, and you see why oil prices have risen so sharply and are unlikely to fall to the low-$20s even after the war.
The household sector is not the only casualty in the energy-price surge. The airline industry, already on its last legs, is further battered by the rise in costs. Many, including Air Canada, Northwest, United, US Airways, Air France and Lufthansa, are adding fuel surcharges to airfares, further eroding consumer purchasing power. The automobile industry, long a stalwart for the recovering economy in the United States and the booming economy in Canada, attributes much of its recent U.S. sales decline to consumer worries about war and higher gasoline prices. Production cuts in that sector are now threatening the strength of Ontario's economy.
And sentiment shocks are also doing meaningful damage. U.S. consumer and business confidence have been falling for months, and the latest survey data, released this week, suggest that Canadians are also feeling less optimistic about their economic futures -- not surprising, given the geopolitical purgatory we are enduring. The "CNN effect" has already set in. Consumers are glued to their TV sets and Internet screens, rather than out shopping, eating, drinking and cavorting. Businesses have postponed investment and hiring decisions, especially in the United States, and many remain fearful of terrorist reprisals as the United States appears to be increasingly isolated and mistrusted.
The U.S. economy deteriorated sharply in February, capped by the ghastly employment report. While the Canadian economy created more than 55,000 jobs last month, the United States lost 308,000. The February plunge in the U.S. employment figures might have been exaggerated by the January bounce, the call-up of military reserves and the East Coast blizzard, but these factors cannot fully explain the extraordinary weakness. It reflects employers that continue to retrench across the board. And the further elevation in the weekly unemployment insurance claims in the United States suggests scant improvement in March.
As a result, stocks have sold off sharply and interest rates have fallen as the safe-haven flight to government bonds continues. U.S. two-year yields have fallen below 1.4%, their lowest level in history. Ten-year Treasury yields touched 3.5% this week, their lowest reading since 1958. Some have speculated that the Federal Reserve will cut the overnight rate from an already depressed level of 1.25% when it meets next Tuesday. In my mind, this is unlikely in that it would do more to arouse concern than to assuage it, especially in the midst of the Security Council countdown. More likely, the Fed will shift its assessment of the economic outlook from neutrality to weakness, preparing us for a rate cut this spring. But we have already seen 12 rate cuts and U.S. mortgage rates are at record lows. It's hard to imagine that the Fed's actions this time would turn the tide.
Instead, what is needed now is a resolution of the Iraqi situation. It appears, in my mind, that barring a miraculous exit of Saddam Hussein, the cost to global security of not going to war may at this point be greater than the cost of doing so. After all the sabre rattling, the United States and Britain cannot blink now without emboldening not only Saddam Hussein, but also Kim Jong-il, the leaders of Iran, and any other dictators. Unfortunately, it appears that the turbulence in the post-Sept. 11 world is far more costly for the United States than anything we saw during the Cold War. The expenses and dangers of being the world's only superpower will continue to be far greater than imagined. A world so dependent on the strength of U.S. demand for imported products will be badly shaken by weakened American purchasing power. The fall in the U.S. dollar -- the rise in the Canadian dollar, the euro and the yen -- is reflective of this. Prolonging the current geopolitical uncertainty will only increase the price we all pay.
Sherry Cooper is global economic strategist and executive vice-president, BMO Financial Group.