the Japanese stock market average has declined from 40,000 to just over 11,000 (July 2004). This decline far exceeds both the length and depth of the U.S. stock market troubles. The Japanese stock market decline provides a measure of Japanese economic weakness. It also reduces the wealth of Japanese people and puts further downward pressure on the global economy.

Even the effect of Chinese economic liberalization has been negative for U.S. producers. Chinese workers make products more cheaply than U.S. workers. The export of those Chinese products has negative effects on the U.S. economy.

Conclusion: Exports are a potential source for economic growth, but given their relatively small role in the U.S. economy, the effect may not be significant.

Governments

The final significant piece of economic consumption is local, state, and federal governments. With overburdened U.S. consumers, idle factories, and less than robust foreign economies, can government spending fuel the economy?

Most of the discussion about government spending revolves around U.S. federal spending. It is important to note that state and local government spending is almost as important as that of the federal government.

In his campaign for California governor, Arnold Schwarzenegger famously remarked, The public doesnt care about figures. 5 That may be an accurate assessment of voter sentiment, but governors themselves must care about numbers. Most state and local governments are legally required to run balanced budgets so when times are tough, their spending must be reduced.

All around the country, state and local governments are cutting services and raising taxes. In order to close its budget gap, New York City raised property taxes. California Governor Gray Davis earned the hatred

of many by tripling the tax on car registration. A similar story is unfolding across the country. The conclusion is that state and local governments will be a drag on economic recovery, not a stimulant.

What about the federal government? As we discussed earlier in the chapter, the federal government has been the major supporter of economic growth by heavy deficit spending. Can the federal government increase the deficit even more and provide more economic growth? Yes. A $500 billion deficit is large by any measure. When compared to the size of the economy, however, the current deficit is much smaller than historical extremes.6 Thus, if needed, the federal government can increase purchases.

There are, however, risks to increased federal deficits. The most obvious is the possibility of rising interest rates. If large, additional government borrowing forces up interest rates, the increase in mortgage rates will depress the housing sector. The U.S. market for homes has remained strong because it has been fueled by low mortgage rates. The housing market will be hurt if mortgage rates rise in response to additional federal spending.

Conclusion: The U.S. government has the potential to increase deficit spending and provide a boost to the economy. However, additional deficit spending may cause an increase in mortgage rates and damage the housing market.

The United States is struggling with a financial hangover. The effects of the 1990s excesses will reduce economic growth.

Bull #1: Economic Eyeglasses for the Short-Sighted

The first optimistic defense of the economy simply looks at the longer trend instead of the recent past. If we cast our eyes back to the immediate post-bubble past, the picture painted above is quite grim. We are told that things are often darkest before the dawn. It is easy to repeat such phrases,

but harder to feel optimistic during tough times. This lesson was demonstrated by one of General George Custers men at the Battle of the Little Big Horn.

There is a story that has been passed around about the battle. As is well known, General Custers men were wiped out and none of his troops survived. According to this story-which would have come from Sioux warriors-one of the cavalrymen had an opportunity to escape. He was riding away and had enough of a lead over his pursuers that his odds were good. At precisely the moment when he looked likely to escape, however, he pulled out his pistol and committed suicide.

The U.S. economy has taken some severe blows in recent years. Yet we may be on the cusp of recovery and ought not despair at what might be our darkest hour. If we take even a slightly longer-term perspective, most economic statistics look quite good. The U.S. stock market as measured by the S&P 500 index is down about one-third from its all-time high (as of July 2004). It has, however, gained almost 1,000% since the stock market bottom in the early 1980s.

A similar pattern emerges across almost all the seemingly dire economic landscape. Interest rates have risen from their lows (including one amazing 50% rise in little over a month), yet rates remain near 50-year lows. Inflation has become so low that the Federal Reserve has spent considerable effort wondering how to stop prices from falling.

Rising unemployment is perhaps the worst aspect of current economic troubles. The unemployment rate has risen by almost 50% and literally millions of people have lost their jobs. Even in this area, the longer-term news is good. As recently as 10 years ago, the current unemployment rate of about 6% would have been considered good news.7

What about the enormous federal government deficit? Surely the rapid swing from large government surplus to gaping deficit cannot be overlooked. Surprisingly, even in this area, the longer-term perspective is very positive. If we measure the amount of U.S. government debt as a percentage of the total economy, the debt is significantly smaller than it