WASHINGTON, 5 March 2007 — Treasury Secretary Henry Paulson yesterday tried to reassure investors the US economy is robust, despite last week’s unsettling stock market plunge.
“I’m feeling good about the US economy,” he told ABC television yesterday.
“Anybody that has watched markets knows that they don’t always over time reflect economic fundamentals and markets never move in any direction forever in a straight line,” Paulson said.
Paulson travels to Japan, South Korea and China this week for talks on global financial imbalances that may have led to the current stock market turmoil.
“I look at and put it in perspective, and say over the last year the Dow’s up over 11 percent the S & P is up nine percent, and I’ll take it.” Investors braced for turbulence after a grim week on Wall Street and other global markets, as analysts debate whether the slide was a correction or the start of a broader downturn.
The Dow Jones Industrial Average of 30 blue chips skidded 4.2 percent for the week to close Friday at 12,114.10, in its worst week since March 2003.
The broad-market Standard & Poor’s 500 index tumbled 4.4 percent on the week to 1,387.17. The technology-heavy NASDAQ composite index plummeted 5.8 percent over the week to 2,368.00.
Paulson also tried to tamp down concern that Beijing could soon dethrone America as the world’s economic engine.
“I would say that our relationship with China is multifaceted and it’s a very important relationship for the US,” he said.
“I don’t believe we need to make China an enemy,” said the former Goldman Sachs chief executive, who warned against protectionist sentiment. “Being open to trade in foreign investment has been one of the pillars in competition that has made this economy great,” Paulson said.
“It’s helped everyone. It’s helped our workers. We’re all going to do better in an economy that is growing and vibrant than one that isn’t,” he said. The US economic expansion suddenly seems more fragile than thought just weeks earlier, after a sharp downward revision to the past quarter’s growth and renewed fears about the slump in real estate. The latest revision to US gross domestic product (GDP) showed the world’s largest economy expanded at a tepid 2.2 percent pace in the fourth quarter, instead of the 3.5 percent growth spurt in the official estimate a month earlier.
That was the sharpest downward revision in a decade, and was attributed to weak business spending and a drawdown of inventories from cautious firms.
Still, most forecasters say the economy will muddle through 2007 at a sluggish pace, in line with Federal Reserve forecasts. But some say the picture is more shaky than it appeared a few weeks ago. And many are renewing forecasts for interest rate cuts by the Federal Reserve sometime this year to help pick up the pace of economic activity.
Manufacturing has been sluggish, highlighted by the 7.8 percent drop in durable goods orders last month.
And some say the US has yet to see the full effect of the housing downturn, reflected in the 19.1 percent slide in residential investment in the fourth quarter.
The end of the real estate boom has resulted in high failure rates among risky or “subprime” mortgages, given to borrowers with below-average credit ratings, and some say this crisis could spill over. “We are seeing cracks in this easy-money-now-not-so-easy environment,” said Andrew Busch, analyst at BMO Nesbitt Burns. He said 20 subprime lenders “have either shut down or been forced to shut down” and more failures are expected. While most major banks are not in the sector, a wave of failures could spread throughout the financial system, some warn.
Stephen Gallagher, economist at Societe Generale in New York, said the sub-prime lending pullback “is a mini crisis that raises questions about complacency in general.” “It has become a case of extreme illiquidity that tends to shake out weaker hands,” he said.
Another concern is the rise in the Japanese yen, which could hurt the so-called “carry trade” that provides liquidity to the US and other markets.
These concerns have whipsawed global equity markets, which saw one of the worst weeks in years, sparked by a nine percent plunge in Shanghai’s stock market on Tuesday.
“Hedge funds borrow yen at very low interest rates to fund US investments. When the yen strengthens, it makes the repayment of those loans more expensive,” said Dick Green, analyst at Briefing.com. “So, perhaps a rising yen will force some hedge funds to sell stocks to cover exchange rate losses. Perhaps.” Paul Sherard, economist at Lehman Brothers, said there may be some economic turmoil ahead but he sees no major crisis. “Wobbly markets probably do not presage serious economic trouble ahead,” he said in a note to clients.
“However, the global economy is still sitting uncomfortably in a configuration of ultimately unsustainable imbalances centered on a current account deficit of 6.6 percent of GDP in the US (2006) and current account surpluses of 9.1 percent in China and 3.9 percent in Japan.”
Sherard said he expects “a gradual but generally orderly unwinding of these imbalances with occasional but inevitable bumps. But the market can be forgiven for getting occasional jitters that a faster and more painful path of adjustment may lie just ahead.” Federal Reserve chief Ben Bernanke told lawmakers Wednesday there was “no material change in our expectations for the US economy” since the official forecast delivered February 14, calling for growth a range of 2.5 to 3.0 percent for 2007.
Bernanke said the downward revision of the fourth quarter GDP numbers “was actually more consistent with our overall view of the economy than were the original numbers.” “So we expect moderate growth going forward,” he added.
The possibility of a recession, evoked over the past week by former Fed chairman Alan Greenspan, has few followers. Among them, New York University economist Nouriel Roubini, who has been calling for a “hard landing” since last year.
“This hard landing will certainly be, at a minumum, a painful growth recession and, much more likely, a much more ugly outright recession,” he said.
Others say the Bernanke view is more likely, saying consumer spending and other segments of the economy are holding up.
“If the US economy is sliding into recession … someone forgot to tell the American consumer. Consumers, who account for 70 percent of economic activity, are still frolicking on the beach oblivious to the swirling storm clouds overhead,” said Sal Guatieri of BMO Financial Group.
Nariman Behravesh, chief economist at the research firm Global Insight, said excluding inventory adjustments and other temporary factors, “you’re looking at growth of around 2.5 percent and we think that may strengthen to about three percent by the end of the year.” He said this situation could mean rate cuts ahead if inflation stays in check, despite the hawkish rhetoric from the central bank.
“Our view is there is still chance that in the middle of the year, with the economy still sluggish, the Fed may cut once or twice. But I’m not going to make a huge bet on that.”
