The U.S. economy in 1999: Goldilocks meets a big bad bear?

Monthly Review, March, 1999 by Fred Moseley

In addition, in recent months a new type of credit crunch has appeared and threatens to be more severe: a credit crunch in the bond markets, in which investors are no longer willing to buy corporate bonds (except the highest grade), or are willing to do so only if these bonds offer a significantly higher interest rate (i.e., only if these bonds offer a higher "risk premium"). Investors have been spooked by the Russian defaults and the near-bankruptcy of Long-Term Capital Management. As a result, there has been a flight from risk to safety (i.e., from corporate bonds to U.S. Treasury bonds). It was this new kind of credit crunch that Greenspan was especially worried about when he engineered the "triple play" reduction of interest rates in October. The panic of the late Summer and early Fall has subsided somewhat in recent weeks, so it looks like the Fed's actions to reassure investors that it has both hands on the wheel of the economy and will not let it veer out of control have been successful so far.(9) However, these fears no doubt remain just below the surface and would very likely reemerge in full force in the event of the next unexpected nasty surprise in the world economy - e.g., further defaults by Russia, capital flight and currency crisis in Brazil, a deepening depression in Japan, intensified class conflict in South Korea or Brazil or elsewhere, or a devaluation of the Chinese renminbi or even the U.S. dollar. If a severe credit crunch were to develop, investment spending would decline sharply (since businesses would be less, or no longer, able to borrow funds for the purpose of investment). Such a sharp decline of investment due to a credit crunch would almost certainly land the U.S. economy in a recession.

Consumer Spending Spree: How Much Longer Can It Last?

The only component of aggregate demand in the U.S. economy that continues to increase at the present time is consumer spending. U.S. households are on an all-out spending spree. The percentage of after-tax income that U.S. households spend (as opposed to save) has always been higher than most other countries - around 94 percent (compared to 80 percent in Japan and 85 percent in Germany). But in recent years, the U.S. spending rate has increased even further, and in the last few months has even exceeded 100 percent! That's right: U.S. households are spending more than their after-tax income (i.e., the U.S. saving rate is negative). Normally, a country with such a low saving rate would have a correspondingly low rate of capital investment, since household savings are one of the main sources of funds for business investment. However, the U.S. economy in recent years has been able to maintain a high rate of investment, in spite of a very low savings rate, became of a very large flow of foreign capital into the United States during this period. In other words, the rest of the world has been willing to provide the savings necessary to maintain investment in the United States, thereby enabling the United States to eat its cake (consumption) and have it, too (investment).(10)