Now what?
Joseph Stiglitz said last week that "there are many ways in which you can see us almost surely being in a Japan-style malaise, it’s just really hard to see what will bring us out." Thomas Hoenig was comparatively an optimist at the Fed conference this weekend, saying: "we’ll slog our way through this" but the best quote from the conference came from Alan Bollard of the Reserve Bank of New Zealand, who was among several foreign central bankers who said they were struck by the unusual degree of pessimism they had witnessed in the U.S. "I can’t wait to get back to my side of the world," he said.
I’ve been blaming the MSM for keeping the public in a constant state of fear and we have clearly divided both the leadership and the punditry into two distinct camps. “The recession is the cure for the disease that affects the economy, but the politicians don’t have the stomach for it,” says Peter Schiff, president of Euro Pacific Capital. “They’re going to keep stimulating the economy until they kill it with an overdose. The hyper-inflation that results is going to be far worse than the cure.”
Most economists who are close to the policy making arena for both parties take the position that austerity is the wrong medicine for what ails the American economy, and they dismiss warnings about inflation as akin to focusing on the side effects of chemotherapy in the face of cancer. First, they argue, take the medicine and stave off the lethal threat; then deal with the collateral problems. Regardless, inflation fears persist, constraining what limited prescriptions might otherwise be thrown at a weakening economy.
Even after the November election, few expect a different dynamic. “We’re already in a gridlock situation, and nothing substantive is going to change,” says Bruce Bartlett, who was a Treasury economist in the first Bush administration. “Clearly, a weak economy in 2012 will be very good for whoever the Republican presidential candidate is. It’s hard to see how the Republicans lose by blocking stimulus.”
The Fed operates (in THEORY) independent of politics and, in Bernanke’s speech on Friday, the Fed Chairman said: "The issue at this stage is not whether we have the tools to help support economic activity and guard against disinflation,” he said. “We do. The issue is instead whether, at any given juncture, the benefits of each tool, in terms of additional stimulus, outweigh the associated costs or risks of using the tool.”
The top option, laid out by Bernanke on Friday, would be to resume buying long-term bonds to drive long-term interest rates down more. The Fed already has purchased $1.7 trillion worth of government bonds and mortgage debt and long-term rates are at their lowest levels in decades. Other officials said behind the scenes that they weren’t sure resumption of the Fed program would be much help. Michael Mussa, former chief economist of the International Monetary Fund, said central bankers, by so aggressively managing the economy’s ups and down, might have made the patient too sick for their own medicine.
Most others at Jackson Hole endorsed Mr. Bernanke’s view that the U.S. economy would resume moderate growth in 2011 after a sluggish second half of this year. "The most likely outcome is that the world is on track for a moderate recovery," said John Lipsky, the IMF’s deputy managing director. The IMF expects to make only minor adjustments to its forecast, currently being reviewed ahead of IMF meetings in early October. "We had always anticipated there would be somewhat of a slowdown in the second half," he said. "Emerging markets are, if anything, stronger than we had anticipated and the latest data out of Europe is better."
As noted in the NY Times by Peter Goodman:
The Fed has also been more creative. During the worst of the financial crisis, the Fed relieved American banks of troubled investments, many linked to mortgages, to give the banks room to make new loans. This engendered the sort of debate likely to fill doctoral dissertations for generations. Most economists praise the Fed for confronting the possibility of another depression. But the Fed added to the nation’s debts, provoking talk that it was testing global faith in the dollar.
The dramatic expansion of the national debt — which began in the Bush administration, via hefty tax cuts and two wars — has ratcheted up fears that, one day, creditors like China and Japan might demand sharply higher interest rates to finance American spending. Those rates would spread through the economy and inflict the reverse of deflation: inflation, or rising prices, as merchants lose faith in the sanctity of the dollar and demand more dollars in exchange for oil, electronics and other items.
So far, the reverse has happened. As investors lose faith in real estate and stocks, they are flooding into government savings bonds, keeping interest rates exceedingly low. Still, inflation worries occupy the people who control money, not least the governors of the Fed. The Fed has been seeking a graceful exit from its interventions, aiming to unload its cache of mortgage-linked investments and — likely in the far future — lift interest rates.
On Tuesday we get the minutes of the Fed’s August 10th meeting and a week from Wednesday (9/8) we have the Beige Book and on Sept 21st the FOMC has another meeting so September is going to be put up or shut up month for Bernanke and company. The Fed cannot do it it alone though. As Bernanke said on Friday: "A return to strong and stable economic growth will require appropriate and effective responses from economic policymakers across a wide spectrum, as well as from leaders in the private sector. Central bankers alone cannot solve the world’s economic problems."
The prospects for household spending depend to a significant extent on how the jobs situation evolves. But the pace of spending will also depend on the progress that households make in repairing their financial positions. Among the most notable results to emerge from the recent revision of the U.S. national income data is that, in recent quarters, household saving has been higher than we thought–averaging near 6 percent of disposable income rather than 4 percent, as the earlier data showed.3 On the one hand, this finding suggests that households, collectively, are even more cautious about the economic outlook and their own prospects than we previously believed. But on the other hand, the upward revision to the saving rate also implies greater progress in the repair of household balance sheets. Stronger balance sheets should in turn allow households to increase their spending more rapidly as credit conditions ease and the overall economy improves.
Despite the weaker data seen recently, the preconditions for a pickup in growth in 2011 appear to remain in place. Monetary policy remains very accommodative, and financial conditions have become more supportive of growth, in part because a concerted effort by policymakers in Europe has reduced fears related to sovereign debts and the banking system there. Banks are improving their balance sheets and appear more willing to lend. Consumers are reducing their debt and building savings, returning household wealth-to-income ratios near to longer-term historical norms. Stronger household finances, rising incomes, and some easing of credit conditions will provide the basis for more-rapid growth in household spending next year.
Businesses’ investment in equipment and software should continue to grow at a healthy pace in the coming year, driven by rising demand for products and services, the continuing need to replace or update existing equipment, strong corporate balance sheets, and the low cost of financing, at least for those firms with access to public capital markets. Rising sales and increased business confidence should also lead firms to expand payrolls. However, investment in structures will likely remain weak. On the fiscal front, state and local governments continue to be under pressure; but with tax receipts showing signs of recovery, their spending should decline less rapidly than it has in the past few years. Federal fiscal stimulus seems set to continue to fade but likely not so quickly as to derail growth in coming quarters.
Although output growth should be stronger next year, resource slack and unemployment seem likely to decline only slowly. The prospect of high unemployment for a long period of time remains a central concern of policy. Not only does high unemployment, particularly long-term unemployment, impose heavy costs on the unemployed and their families and on society, but it also poses risks to the sustainability of the recovery itself through its effects on households’ incomes and confidence.
That brings us back to the Administration, then – which MUST take action to reduce unemployment.
IN PROGRESS
