Another US slump would be blow to Ireland

INCREASED nervousness about the pace and state of economic recovery in the US has pushed the euro back up from its recent lows of $1.13 to over $1.15 against the world’s leading currency.

And this latest euro dollar rally looks set to continue as uncertainty about if and when the mighty US finally decides to leave slow economic growth behind.

Perhaps of even greater concern is the question of deflation, the technical term dreaded by most investors.

Alan Greenspan recently avoided use of the word in his assessment of future prospects for the US economy and the dollar rallied to some degree. In his most recent outing before a Congressional Committee, Greenspan more or less dismissed the deflationary threat. His stance was enough to put a floor under the dollar, and bond yields started to fall in the belief that the chairman of the US Federal Reserve would not be cutting interest rates any further in an effort to boost economic recovery.

In other words, recovery was underway, however tentative, and the low interest rate cycle had hit bottom was the veiled but definite message from the Fed chairman. The key concern then was that the resultant rise in bond yields would push up the cost of mortgages and make it more costly also for businesses to borrow.

Those twin happenings could be a dagger in the heart of the US recovery and prompted a definite cautionary follow-up comment from Ben Bernanke, a member of Greenspan’s committee that sets interest rates in the US.

In a statement given in a paper called “An Unwelcome fall in inflation” Bernanke said the Fed would cut rates all the way to zero if necessary in order to get the recovery in the US back on track.

His comments were two fold. To take pressure off bonds and to caution that the much vaunted recovery in the US is still difficult to identify in any meaningful way.

Bernanke’s remarks effectively made bonds cheaper to buy which meant the US consumer and US businesses could continue to borrow at very favourable rates and thereby continue their critical role in helping the US back into more normal growth patterns.

Those two groups are core to any recovery in the US and that Bernanke has moved as decisively as he has, suggests that Greenspan and the Fed were sufficiently worried to correct the over-optimism that has gripped the markets since his last public comments on the state of the economy.

What about the Irish economy? Why the fuss about the US. The problem is that both are interlinked. Much of the downbeat forecasting on Ireland of late from the Central Bank and others would have been a lot worse if framed against the backdrop of Bernanke’s more recent comments on the likelihood that recovery was more fragile than earlier indicated by Greenspan.

As of now, we seem to be talking about very modest recovery in the US, if it does happen.

Bernanke in his paper said “if” the US recovers it would remain fragile until 2005.

The “if” was not for dramatic impact. His comments that the Fed will cut rates to zero if necessary suggests the mood in the US is more sombre than the stock market rally since March has suggested.

This is bad news, because much of the muted optimism in reports from the Central Bank and the Economic and Social Research Institute is based on a pick-up soon in US activity. If the US goes ito another recession, then the Irish economy could hit very serious trouble.

The job losses are a worry. Unfortunately, they are the direct result of the previous US slump. If another crack appears in the US system in the coming months, then unemployment could worsen.

Businesses have been up in arms for some time over excessive costs and huge concern has been expressed that the Government has lost its grip on the economy, an argument that is becoming harder to counteract as increasing numbers argue that insurance and other costs are driving them out of business. That situation cannot be sustained indefinitely.

Nevertheless, the recent spate of corporate results out of the US suggest that recovery of sorts is underway and hopefully, that pattern will be sustained.

That remains to be seen, however, and the pessimists are beginning to look like they might have their day after all.