America's Economic Future: The Ineluctable Plunge

The subprime mortgage crisis has captured recent headlines in economic and financial reports. Unarguably, foreclosures and mortgage defaults have delivered a severe blow, one which threatens to send America's economy into recession. The upcoming election coupled with newfound fear of an economic slump puts the economy back into the forefronts of discussions, giving attention to more fundamental issues such as the devaluation of the dollar, national debt, and over consumption, topics which have been threatening the economy for years without receiving the same attention as the mortgage crisis. Though more thought has been given to the current state of our economy, it is not enough. Without proper fiscal and monetary guidance, America could potentially face conditions reminiscent of the 1930's. The weakening dollar will deter foreign funding of government bonds and eventually, assuming no miraculous influx of money, the national debt will force the government to cut expenditures, jeopardizing education, social programs, and other important services. The devaluation of the dollar will also pose serious financial dilemmas for American manufacturing companies who outsource their work as well as to consumers who will be forced to spend more money on goods. Given these impending issues, I have decided to probe blog posts discussing America's recent economic developments. The first post I decided to comment on was written by Tim Duy, an adjunct assistant professor in economics from the University of Oregon, but posted by his colleague Mark Thoma on the blog Economist's View. Tim Duy analyzes recent interest rate cuts to determine the Federal Reserve's current position on the economy and possible future implications. The second post I decided to comment on is by a retired economist strategist and International Monetary Fund employee, Desmond Lachman, and is hosted on a geopolitical web publication. Desmond touches on various factors threatening long term growth and provides a summative break down of each point. I submitted my comments to each blog and posted a copy below.

"Fed Watch: Fed Set to Cut Again, But Looking For a Chance to Pause" Comment:

The Federal Reserve does seem incapable of promoting the confidence required to rally people but I too want to believe. What I do believe, though, is that recent housing afflictions have aggravated and hastened an already serious problem in the economy and the Federal Reserve would be naive to believe interest cuts will remedy or divert the inevitable clash of several key economic complications. Bernanke's (right image) wishful tone when discussing future interest cuts (or should I say lack thereof) is "commendable" but also a blatant lie and a failed attempt at shaping market participant's beliefs, as your colleague noted. I enjoyed reading your colleagues piece and I found it very informative; however, though Tim is most likely correct about future interest cuts, I disagree on a couple points. The current interest rate at 3% will drop incrementally over several months, but the target 2% predicted by Tim appears as a shy estimate. American manufacturing and unemployment growth are far from impressive and given the housing market (including byproducts such as utilities and manufacturing) is approximately 10% of the GDP we can assume interest rates will drop closer to 1%. The Federal Reserve has tremendous pressure on its shoulders and if history is any indicator than such a decrease is almost certain. Additionally, I do not believe this will be "an end to end this cycle." Most likely, there will be economic tension more damaging than market correction under moderate interest cuts. The financial sector is already strained from red ink and even with interest cuts there will be hesitation in lending practices. On a more global level, Tim is right, other countries will want to avoid the high risk of inflation and stop funding America's debt. However, the "impact of past policy" will not be felt with much firmness by summer. Any threat of further decline will amplify economic weaknesses already present such as the devalued dollar and national debt. The economy will continue to rise and fall, but each fall will outweigh previous gains. Maybe the economic stimulation package will provide a silver lining, but most likely we will have to hope the next president will implement comparatively sound economic policy. This cycle has just begun.

"Bearing Down - The Coming Recession" Comment:

I agree very much with most of the points established in your post. And it is frightening to even suppose the similarities between Japan's 1990 economy (left image) and our own. The asset price bubble ballooned since the dot-com crash and the heavy reliance on the housing market for GDP growth has become painfully obvious. America is now stuck in a balancing act; the government has to find a way to deflate the bubble without crippling the economy. Unfortunately, I do not believe there is neat solution. At some point the market will correct itself and in our current state, an overabundance of fiscal and monetary policy may prove to be more detrimental than helpful. The government has to avoid worsening economic weaknesses, namely inflation. In fact, America would not even have to experience full fledged inflation to feel its repercussions. As soon as foreign entities detected unmanageable risk we would witness a rapid flight in funding. Though I agree the government has to react in some capacity, I am not sure I believe Bush and his administration "have finally grasped the urgency of the present situation." Or if they have, then another agenda is affecting their performance. The Federal Reserve is limited in its economic tools and the burden is on Congress and the Executive Branch to execute policy which will promote growth and tighten certain fiscal sectors. For example, I strongly believe temporary credit codes need to be implemented to begin counteracting the credit crunch and restricting plastic based consumption. Furthermore, immediate and aggressive policy to reinforce American jobs and production need to be established. Stimulating the economy from a monetary stand point, such as tax refunds, will not establish long term growth and will only delay the inevitable. That being said, how do you think current solutions will impact our economy in the long run? Do you believe it will provide a realistic opportunity in diverting massive recession? Or do you believe "we are due" given the many problems with our Economy? And finally, what types of changes need to be realized to insure long term stability?

Dubai: An Attempt at Transmuting Sand into Gold

The 21rst century is witness to unprecedented developments, a hallmark of globalization, and no entity better exemplifies this progress than Dubai. The emirate plans to rival China's economic growth rate within the next decade, targeting 11% by 2015. Already surpassing expectations set for 2010, there is little doubt Dubai has become an economically diverse powerhouse in the Middle East. The large, vested interest in rapid expansion results from the fact that within ten years the current rate of oil extraction will deplete supplies, forcing Dubai to rely solely on alternative domestic productions. Luckily, heavy investment in growth sectors such as tourism, finance, manufacturing, and free zone privatization has allowed Dubai to reduce oil dependency to less than 6% of its gross domestic product (GDP). In essence, Dubai's objective is accomplished. However, the price aggregated during their expedited growth may prove to be too costly.

The massive amount of construction occurring (as seen in the image on the right) demands large quantities of immigrant laborers, specifically Indian expatriates. Theoretically, if worker supplies can continue to grow, aggressive building techniques pose no imminent threat. Unfortunately, Dubai's labor vulnerability is vividly apparent. Just recently, the Economist reported that 40,000 workers "expos[ed] the frailty of Dubai's economic boom" by bringing several large projects to a two-week standstill during a strike. Simultaneously, India's prosperity is providing competitive jobs for expatriates and forcing construction companies to raise wages. Heightened tensions stemming from increased costs, unstable work groups, and alternative employment are characteristics of economic volatility. Though Dubai continues efforts in improving laborer accommodations by placing pressure on respective employers, there is no adequate way to quell the increasing need for migrant workers.

Additionally, there are natural resource problems. A region containing over half of the world's identified oil reserves is, ironically, desperately struggling with energy issues. In 2005, blackouts and spikes in oil prices demonstrated even the Middle East is not immune from energy shortages and this presents a serious problem for a Dubai that depends on constant power to sustain its radical growth. To compound the problem, Dubai Electricity and Water Authority stated "power...demand is rising by an average rate of 20%...each year." Much like the worker strike that halted construction, if energy supplies dwindle to levels restricting ongoing projects, Dubai could find itself in a serious financial quandary. Billions of dollars invested in incomplete projects is sunk cash that will provide no return. However, even if Dubai is capable of obtaining enough natural resources and workers to complete constructions, future success is based on the assumption that incredibly large amounts of energy will be disposable. Although solar power may present a solution to this problem, it is far from established and only underlines the speculative nature of Dubai's growth strategy.


An alarming example that demonstrates the absurd amount of power expected to be consumed is Dubai's indoor ski resort (as seen in the image on the left). The structure will be approximately 400 meters in length and 18 meters high, housing over 6000 tons of snow at fluctuating temperatures below 0 degrees Celsius. This will be accomplished in an environment that frequently breaks 40 Celsius and can reach temperatures as high as 48 degrees Celsius. Though it appears no specific energy estimate has been publicly published, just theorizing about the amount of power required to keep a "warehouse" below zero in such a hot climate is astronomical. Considering the body of energy Dubai will depend on in the future and the lack of established, foreseeable alternatives, such an ambitious development plan is a high risk investment.

Dubai's problems are broader than just construction and resource dilemmas. Currently, the emirate is home to over 1.5 million people and roughly 70% are expatriate workers. As land development slows, available construction employment will decrease and substitute jobs will have to be found. The problem is that the jobs available will be imported professions requiring a certain degree of education. Even with recent improvements in teaching facilities, there will be a lack of instructors to appropriately accommodate the demand. One may argue that Dubai's large service industry will provide a niche for low skilled workers. Though this is true, it will still be impossible to satisfy the rapid assimilation of over a million laborers. Alternatively, the government could expel people, but since such a large majority of the population is expatriate, the risk of social upheaval makes this an unlikely solution. Furthermore, foreign investment and immigrant businesses have replaced oil but are far from permanent fixtures. Christopher Davidson from Shariah Finance Watch says that any economic swing triggered by aforementioned problems or instability rising in the region can create a massive evacuation of foreign capital. After extensive investigation, I believe the underlying issue surrounding all of Dubai's problems is the absence of developed social and economic infrastructure. Successful, rapid growth requires stability in both realms.

Investing heavily in tourist and service industries, massive construction, and outlandish amenities is a recipe for rapid but risky growth. The major focus of Dubai should be human capital and gradual political reforms; primarily, education and the creation of a stable and productive work force. Afterwards, Dubai should demonstrate economic and political stability within its own borders and with neighbors such as Iran to encourage foreign business growth. This plan would reduce the demand for natural resources and laborers and render Dubai self-sufficient, relying on less risky inputs. Unfortunately, the Arab world has proved to be remarkably stubborn and my proposal requires the distribution of wealth, not an appealing perspective granted the leaders of Dubai want to consolidate national pride in the form of extravagance and the population largely consists of immigrants.