THIS July, when I first interviewed John Snow in London, the world economy was just beginning to emerge from the trauma of the Iraq war but the US Treasury Secretary was in ebullient form. The US economy, he insisted, was on the verge of a spectacular recovery from the three-year malaise that began with the collapse of technology stocks on Wall Street and was aggravated by the horror of September 11.
The American economy, he maintained, was “coiled like a spring and ready to go”.
This remark was widely quoted in the media and greeted with scepticism, bordering on derision. Three months later, as I met Mr Snow again in his Washington office, he was entitled to gloat.
“The spring has now sprung,” he declared as our conversation started. “I am confident that this economic recovery will now be sustained and will produce loads of new jobs. Everything we know about economics indicates that the sort of economic growth expected for next year, 3.8 to 4 per cent, will translate into two million new jobs from the third quarter of this year to the third quarter of next year. That’s an average of about 200,000 new jobs a month.”
With a US election approaching, the figures he mentioned were significant in political as well as economic terms. Two million is the number of jobs the Bush Administration is accused of “destroying” since it took over the White House and the rule of thumb among US economists is that 200,000 new jobs a month are needed for the unemployment rate to show a sustained decline.
“What gives me confidence? Everything we know about economics and history.
“Consumption and housing remain strong. Now capital spending is clearly coming back and inventories are at astonishingly low levels. Jobs are always a lagging indicator which follows economic growth. I would stake my reputation on employment growth happening before Christmas. I’d bet dollars to doughnuts that we are going to see a pick-up in employment in 2004.”
But surely there is a serious qualification to this optimism? If economic growth does take off as suggested, then surely interest rates will start to rise?
Recent statistics on consumption and industrial production suggest that the US economy grew by 7 per cent in the third quarter. In such an environment, the Federal Reserve might well consider raising interest rates. On Wall Street, however, the futures markets imply that interest rates will rise by no more than one quarter or half a per cent before the summer and several leading banks expect no tightening at all until 2005. Surely, markets may be in for a nasty surprise? Mr Snow seemed totally unperturbed.
“Economic growth is a process of constant adjustments. If you’ve got productivity running at very high levels, you will get higher real wages and profits. Rates of return are up and as long as the expected return on capital is higher than the cost of capital, businesses will expand and the adjustment process kicks in.
“The price of capital is interest rates and there is going to be a need for a capital rationing process. Higher interest rates are an indicia of a strengthening economy. I’d be frustrated and concerned if there were not some upward movement in rates.”
But what about politics? Next year will see a fiercely contested presidential election. Wouldn’t an increase in interest rates at such a time interfere with the political process?
Mr Snow was completely dismissive of this argument. It may be an article of faith on Wall Street that the Fed tries to avoid raising interest rates before elections, but this is factually untrue. The idea that the Fed doesn’t move in election years is just “an amazing sort of mythology”, Mr Snow insists. After our interview, I check the historical record and discover that he is right. The Fed has raised interest rates sharply in three out of the past five election years, most recently in 2000. Moreover, while Wall Street mythology contends that the Fed lost President Bush’s father the 1992 election, the record shows the opposite. The Fed cut interest rates by 2 percentage points in 1992. In the 1988 polls, by contrast, interest rates were lifted from 6.5 to 8.5 per cent, yet that was the election won by the first President Bush.
Turning to questions on the dollar, Mr Snow indicated that the US policy had been misunderstood by many commentators, though not by the markets themselves. The dollar has fallen sharply in the four weeks since a statement issued in Dubai by G7 ministers, which called for “greater flexibility” in exchange rates. Mr Snow had hailed this statement as “a milestone” and this comment was widely interpreted as a hint the US wanted to see the dollar decline. Mr Snow insisted, however, that the real milestone he referred to was the commitment of all the G7 countries to pursue policies to stimulate domestically led growth.
The US had never intended to talk the dollar down. Although Mr Snow did not express any views on individual exchange rates, another senior Treasury official noted that the comments in Dubai were directed solely at countries that attempted to manage or control their currencies, not at market-based exchange rates such as the dollar-euro rate.
The US was not trying to persuade China to float its exchange rate in the short term, but rather to make the financial changes needed for a market-driven currency to be set one day. Moving to a floating rate would be “ill-advised” before the financial reforms were in place. “They are not going to get there overnight and we recognise that,” he said. In Japan, too, Mr Snow welcomed the economic reforms undertaken by Junichiro Koizumi, the Prime Minister. He refused to be drawn on whether he was satisfied with the strengthening of the yen since Dubai.
But another Treasury official noted that Japan had reduced the scale of its currency intervention and no longer seemed to be defending arbitrary exchange-rate levels, as it had been before Dubai.
