The Cracks Are Showing

From the signals of a weak labour market to American retailers filing for bankruptcy protections, the start of a possible major economic downturn in the US economy has begun.

The weak labour market can be seen from the claims of job unemployment benefits by the unemployed. The number of US workers remaining on job unemployment benefits rose to 2.94million in the week ending 29 March 2008, the highest since July 2004. ("US jobless claims drop 53,000 in latest week" by Singapore Business Times, 10 April 2008.) This could be due to companies putting hiring on hold and/or laying off staff in anticipation of a slowdown in demand for their products.

As for American retailers, 8 mostly middle size retail chains have filed for bankruptcy protections while others have started to downsize their operations in anticipation of an economic downturn. ("Retailing Chains Caught in a Wave of Bankruptcies" by Michael Barbaro, The New York Times, 15 April 2008.) Retailers are faced with 2 main problems, consumers spending less and the inability to obtain loans easily from banks.

Consumers are spending more on necessities like food and oil(petrol) which are income inelastic. This results in consumers having less disposable income for other luxury goods which are income elastic. The final effect, retailers having less revenue to cover their fixed costs which for some, are not even able to cover their variable costs such that they are forced to close down. In this case here, they seek bankruptcy protection.

The collateral debt obligations (CDOs) crisis has created a credit crunch among banks as they are cautious in lending towards one other. This has made the Federal Reserve to reduce interest rates to spur lending. However, it seems that the Feds' efforts have been futile as banks are unwilling to lend and/or extend credit facilities to the retail chains. This has created cash flow problems for the retail chains in making payments to their suppliers which only push the retail chains into bankruptcies.

The falling US dollar does not help the economy at all. The weaker dollar creates import-inflation as mentioned in my previous article, "Greater Possibility or Has It Arrived?" 21 February 2008. If the US economy is the final consumer of imported products, with US demand being inelastic, consumers will face increasing price rises such that they would have little to spend. For March 2008, US Producers' prices rose by 6.9% on a year to year basis.("U.S. Producer Prices Up 1.1% in March", by Reuters, The New York Times, 15 April 2008).

The Fed has used monetary policy to try to advert a possible downturn. But to no avail it seems judging by the result of the decline in consumer confidence. ("US consumer confidence takes a beating", Singapore Business Times, 12 April 2008.)

Should monetary policy be ineffective, there is another method. Examine the equation of the Gross Domestic Product:
GDP = Consumption + Investment + Government + (Exports - Imports)

With consumption and investment possibly dropping and imports increasing, the way out for the US Government is to use fiscal policy or have the US economy export its way out from recession. With the US Government providing tax rebates cheques to households, it is hopeful that this would spur the increase in consumption. If not, it is going to be a long recovery from the downturn.