Under pressure
Glenn Cheney talks about Hurricane Katrina, rising fuel prices, military infractions and why the US economy is under considerable pressure.
The US is an extraordinary country, often in extraordinary situations, and these days, its economy is suffering extraordinary pressures from extraordinary forces. Interminable military actions drain its treasury. Hurricanes have ruined key ports.
Gyrations in fuel prices have consumers wondering how they?ll stay warm this winter and whether they can afford to drive to work. The federal deficit swells to unimaginable proportions, the trade deficit soars out of sight, and the almighty dollar is circling the drain.
Rick Telberg, a columnist and CEO of Bay Street Group Ltd, a consulting firm to public accountancy firms, has been monitoring economic forces acting on not only the country but also on the accounting profession.
‘Finance directors and accountants in the US are dealing with a wave of economic issues they hadn?t foreseen a year ago, and they?re getting increasingly worried,’ Telberg says. ‘The central bank is jacking up interest rates to suppress inflation. A housing bubble seems ready to pop, which could seriously crimp consumer spending. The federal deficit has financial professionals fearing setbacks in financial markets and increased borrowing costs, along with a sudden drop in consumer demand.’
Within the profession, Telberg says, finance directors and accountants are dealing with huge new costs created by the Sarbanes-Oxley Act, uncertainties about the standards-setting hierarchy, weakness in the profession?s reputation and political clout, spiralling health care insurance costs for labour, and an uncertain tax situation after major crackdowns on big accounting and law firms that had promoted dubious tax shelters.
Enter Mother Nature. Back-to-back hurricanes ? named Katrina and Rita ? devastated New Orleans and a number of other ports.
Katrina has been said to equal ‘one war in Iraq’, not in terms of destruction but in cost. The financial toll of the war has reached US$200 billion, running an average of US$1.5 billion a week. The financial toll of the hurricanes may tally up as high, though it depends on how the money is counted. Several cities must not only be rebuilt but decontaminated of environmental hazards.
Since New Orleans is the ocean port of the Mississippi River, farmers in the national breadbasket to the north have been unable to ship their crops. Scores of cities, denied revenues from property and business taxes, may default on bonds.
Katrina affected accountancy, too. CPA firms had to flee New Orleans, and those that have returned find their clients swamped, swept away, or otherwise bereft of personnel or infrastructure.
Bill Balhoff, partner with Postlethwaite & Netterville, has offices in New Orleans and in the state capital, Baton Rouge, just to the north. His New Orleans staff spent weeks working elbow-to-elbow in a training room at the Baton Rouge office, and many had to bunk in the homes of their peers. It took more than a month before the New Orleans office could be re-opened.
The only good news for the firm: its technology subsidiary has lots of business helping clients recover records and reconstruct information systems.
Meanwhile, accounting firms across the country offered shelter from the storms, promising temporary jobs to any CPA who needed work away from home. They even promised to return the evacuees as soon as their home offices were back in operation ? quite a gesture in a country suffering a chronic shortage of accountants.
‘The response within the profession around the country has been awesome,’ Balhoff says. ‘In many cases, tragedies bring out the best in people, and that has certainly been the case in response to Katrina.’
Barry C. Melancon, president and CEO of the American Institute of CPAs, and a former resident of the New Orleans area, says the hurricanes did more than disrupt a commercial ecosystem. The damage to oil rigs and refineries has aggravated a national fuel shortage.
‘The impact on oil is affecting everyone?s pocketbooks, though that will subside as facilities return to operation,’ Melancon says. ‘But the high price of gas has minimised people?s disposable income, and the ripple effect will be seen across the economy. Demand-driven construction material costs will also have a ripple effect for two or three years. So even though the damage was in just one region, Katrina is having far-reaching effects.’
The hurricane was also a blow to the federal budget. To cover the cost of Katrina, President Bush is pressing to reduce overall spending ? and refusing to desist from his efforts to reduce taxes. To some, that?s a silver lining. To others, it?s a dark cloud. Those of the silver lining persuasion say reconstruction will boost economic activity. Those who see an unlined dark cloud fear a budget slashed of social programs and still operating in the red.
With the federal government already operating in a fiscal abyss ? US$7,932,709,661,723.50 as of 30 September ? all these extraordinary expenses must be paid for under deficit spending. The total recovery cost may be only 1 per cent of the national GDP of US$12 million million, but the interest on the national debt will add US$12 billion a year for many years to come.
Congressman Jim Saxton, chair of the Joint Economic Committee and a patriotically optimistic Republican, says the economic impact of the hurricane will be transitory.
‘The extraordinary resilience and flexibility of the US economy fostered by positive monetary and tax policies, so far have proven to be more powerful than the unusual negative forces [such as Katrina, fuel prices, the deficit, etc.],’ he says.
Saxton says though the price of oil may slow the economy in the short term, conserving by consumers and increased energy efficiency will restrain demand. The decline of the dollar is not a concern, he says, as long as the Federal Reserve continues to keep long-term inflation under control. Deficit spending signals the need for a tighter federal budget, he says, ‘but as a percentage of GDP, the deficit still remains well below historic highs reached in previous decades.’
The Government Accountability Office is less optimistic. It identifies social entitlement programs as all but dooming the economy.
‘GAO?s simulations lead to an overarching conclusion: current fiscal policy is unsustainable over the long term,’ a recent GAO report warns. ‘Absent reform of federal retirement and health programs for the elderly … federal budgetary flexibility will become increasingly constrained. Assuming no changes to projected benefits or revenues, spending on these entitlements will drive increasingly large, persistent, and ultimately unsustainable federal deficits and debt as the baby boom generation retires.’
Sustaining the US economy is a massive influx of capital from abroad, resulting in huge offshore reserves in dollars. That helps hold interest rates down, but as the balance worsens, an uncontrollable collapse of the dollar could do a financial Katrina on the whole world.
‘We are skating on increasingly thin ice,’ Paul A. Volker, chairman of the International Accounting Standards Committee, wrote in a Washington Post editorial in April. ‘On the present trajectory, the deficits and imbalances will increase. At some point, the sense of confidence in capital markets … could fade. Then some event … could come along to disturb markets, with damaging volatility in both exchange markets and interest rates.’
Meanwhile, corporate scandals have rattled investor confidence. A jittery reluctance edges the securities market upward only to let it stumble back down, resulting in a kind of dangerous stagnation.
Barry Melancon says that investor confidence has been extensively restored.
‘If you look at confidence in the American capital market system today, it has recovered pretty well,’ Melancon says. ‘Even though people don?t always understand everything that was done, they understand that something was done.’
But the connection between corporate scandal and investor confidence isn?t quite so simple. The cure may have created a problem. The Sarbanes-Oxley Act had the laudable intention of making corporate officers more responsible, tightening internal control, and intensifying audits. Though it has improved accounting and accountability, the improvement has come with a cost: by some estimates a total approaching US$35 billion.
Jeffrey Thompson, vice president of research and practice development at the Institute of Management Accountants, says the cost of implementing Sarbanes-Oxley has been steep, but that represents only part of its economic effects.
‘The hard-dollar cost ? make no mistake about it ? has been a huge drain on the economy,’ Thompson says. ‘What?s less understood, less documented and less quantifiable, however, is the opportunity cost: shifting resources from business development and innovation.’
Sarbanes-Oxley and a host of other financial and environmental regulations, Thompson says, may be countering some of the confidence they were meant to bolster. Citing a recent report, he says that ‘regulatory risk’ is widely seen as the most significant threat to businesses, ahead of political, market, and credit risk. And the US had the highest perceived risk.
IMA chair-elect William Brower, a vice president of finance at the Johnson & Johnson company, says sustainability will affect the US economy as companies are increasingly required to report on the environmental impact of corporate actions. ‘Over time, in order to meet the requirements of international standards, US corporations will be forced to change not only their accounting but also the way products are produced,’ he says. ‘That will potentially impact the economy.’
Despite the onslaught of economic woes, the US can still count on its greatest and most sustainable asset: its legendary ability to innovate.
Mark Heesen, president of the National Venture Capital Association (NVCA), sees that capacity as a force to be reckoned with.
‘When we look at the new technologies coming down the pike, we see a continuation of the very vibrant productivity gains we?ve had over the last 10 years,’ Heesen says. ‘This will help the current economy despite a lot of issues that have come up, the biggest being energy.’
Heesen says NVCA members are describing today?s internet technology as ‘just the tip of an iceberg’. At the same time, the health sciences are expecting huge gains in efficacy. Digital technology, the internet, and healthier baby boomers will combine to create a new driver of the economy: oldsters who have computers in their homes, time on their hands, and cash in their pockets.
Heesen even sees good things in the energy crisis. The high price of oil is on the verge of inspiring new technologies in energy production and conservation. ‘There are other things that people won?t talk about because they?re putting them together in their garages,’ he says. ‘They don?t want to give away their secrets. That?s the heart and soul of the venture capital industry.’
That irrepressible urge to innovate may also be the economic force that trumps all others. If anything explains the persistence of the American economy, that?s it.
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