The end of summer clarifies very little about US economic and financial prospects. To be sure, the August employment report showed improvement. Including revisions for the two prior months, non-farm payrolls are now more than 300,000 higher than they were in May. Business surveys still point to increased output, orders, and capital spending plans. Commercial construction is also up, after a prolonged slump. But retailers are not so optimistic. Unseasonably cool summer weather in the highly populated Northeast and Midwest and major hurricanes in Florida discouraged shoppers. And persisting high gasoline prices are also a drag on consumption. Even the super-charged US housing market has displayed some tentative signs of simmering down.
The US bond market, sensing consumer confidence is wavering, fears a severe slowdown. Traders have scrambled into bonds, producing a sizable bond price rally. By contrast, many mainstream economists, notably those at the Fed, expect the opposite: a renewed acceleration of growth. Senator Kerry hopes the bond market is right, and President Bush hopes the Fed is right. The stock market doesnt know what to believe and has been struggling. Most investors are waiting until after the election before committing more money to the stock market.
In the meantime, the dirty little secret of the US presidential campaign is that so far neither candidate wants to talk much about the two big issues that will challenge whoever wins the election: the large Federal budget deficit and the giant US trade deficit. The budget deficit is as much the result of what Congress does, because no White House gets everything it wants on fiscal policy. But international economic policy is squarely the responsibility of the administration and cant be delegated.
The US trade deficit is now running at about $600 billion a yearover 5% of GDP and rising. Up to now it has been financed easily, mainly by Asian official institutions. But one day it will need to be lowered. To achieve that, the standard prescription calls for a combination of slower US growth and currency depreciation. Naturally, no presidential candidate is going to campaign on a platform of slower growth. So President Bush blames the trade imbalance on weak foreign economic growth. Challenger Kerrys platform attacks the Bush administration for not enforcing trade agreements and allowing foreign countries to keep out US products. China is mentioned most prominently, along with Japan and South Korea. His solution is to hire better trade negotiators.
Neither candidate says anything about exchange rates. There are good reasons why not. If President Bush were to call for a weaker dollar, it would be an admission of failure. The trade deficit has doubled during his term in office, and nothing has been done about it.
But why doesnt Candidate Kerry seize the opportunity? No one knows. But I suspect it is because he is already vulnerable to the charge of flip-flopping. In the case of the dollar, the charge would stick. After all, the Clinton administration enthusiastically pursued a strong dollar policy, as engineered by then-Treasury Secretary Rubin. Senator Kerry, along with most Democrats, supported Rubins position. That makes it difficult for him to break with the Clinton policy legacy now, even though a decline in the value of the dollar, especially in Asia, makes sense under todays changed circumstances.
Once the election is over, however, the issue of the dollar will quickly move to center stage. The reason is that a major US industry that employs hundreds of thousands of American workers is in serious trouble: the US auto industry. In the second quarter of 2004, motor vehicle output plunged by 20% at an annual rate. It subtracted almost a full percentage point from US economic growth. And it continues to contract; both Ford and GM have announced production cuts for the final months of 2004.
Admittedly, not all of the industrys problems can be traced to an overvalued dollar. Management weaknesses, unappealing products, and unaffordable commitments for pensions and retiree health care all contribute. But the strong dollar is a factor and is easier to fix in the short-term than the rest of the causes.
So whether the overall US economy does a little better or a little worse in the coming months, the question of what to do about the trade deficit and the dollar will not stay in the shadows for much longer. The financial markets will have more to think about after the election than they now realize.