US Consumers Feel at the Mercy of Events

If you are having difficulty reading the conflicting signals coming out of the American economy, you are not alone. Consider this: a Los Angeles Times/Bloomberg poll shows that 78% of Americans think we are in an economic recession. A virtually simultaneous CBS News/New York Times poll found that 72% of Americans rate the financial situation of their households as “good”.

This reminds me of the old joke about the man who denies that he is having a relationship with another woman when his wife discovers them in bed together. “What do you believe, your own eyes, or what I tell you?” Apparently, Americans believe the media, which are telling them there is a severe recession, even though their own eyes are telling them things aren’t so bad.

But don’t blame it all on the media. There is good reason for confusion. Many homeowners are in or close to default, but the vast majority are not. A majority of the Federal Reserve’s monetary-policy gurus decided to lower interest rates at their last meeting, but a significant number of key members feel that inflation, not a recession, is the biggest problem the Fed faces. Banks report new write-downs, dropping more than one second shoe, but they also report that they have been successful in raising new capital to shore up their balance sheets.

Most confusing of all, the government reports that inflation is more or less under control. Core inflation — excluding food and fuel — rose only 0.1% last month. Good news — unless you eat, or own a car.

Food eats up about 13% of household budgets, so when egg prices jump 40% over last year’s level, milk prices go up 26%, and bread prices rise by 15%, household finances are strained. Petrol is a less important component of household budgets, accounting for about 4% of total spending. But four circumstances make fuel an important inflation indicator for the average consumer.

First, consumers not only buy petrol often, but pass giant signs proclaiming the new, higher prices several times every day. Second, the increase in prices has been extraordinarily rapid — from under $3 per gallon (40p a litre) last year to close to $4 (53p a litre) now. No gradual adjustment has been possible for motorists.

Third, the knock-on effects are obvious: among other things, airline flights are being eliminated to save fuel, fares are rising and ancillary charges being invented, making that summer vacation more expensive.

Fourth, America’s summer holiday driving season starts this weekend, and many consumers will be forced to stay at home rather than watch the dial at the petrol pump spin at a dizzying rate. Indeed, some pumps now reach the highest total they can record, and shut down, before the tanks of bigger cars are full.

There is something less obvious but more important than the dollar impact of this fuel and food inflation. It adds to Americans’ sense that events are in the saddle and ride mankind. Prices are out of control; foreigners control the oil on which we depend and the price we pay for it; the president gets short shrift from robed rulers of a tiny kingdom that happens to sit on large reserves of oil; suicide bombers in cloth robes mock our armed-to-the-teeth soldiers in Iraq; China pays the higher oil and food prices but continues to produce goods far more cheaply than we can. There’s more, but you get the idea: as Cole Porter would have put it had he studied economics instead of music at Yale, after what some have called a not-so-quiet credit and buying spree, Americans find themselves fighting vainly the old ennui.

To make matters worse, 70% of Americans disapprove of the way President George Bush is handling his job, and an even larger percentage say Congress’s performance is dreadful. Little wonder. Congressional committees made something of a spectacle of themselves last week by grilling oil-company executives whom they blame for high oil prices, while barring them from exploring for new reserves in Alaska and offshore California, Florida and other states. Worse still, the farm lobby combined with liberal groups (the bill included the odd billion for anti-hunger programmes) to persuade Congress to appropriate some $307 billion for mostly rich farmers whose incomes have already been driven skyward by the rising price of the foodstuffs they produce. The billions in handouts will flow even if food prices continue to rise. Bush, never known for his fiduciary relationship to taxpayers’ money, promptly vetoed it, only to have his veto over-ridden by huge votes in both houses of Congress.

Almost 50 years ago the economist Mancur Olson pointed out that small determined groups — what we now call special-interest groups — could push through measures that benefit them at great cost to society as a whole. He was right.

But a $14 trillion economy can tolerate a good deal of waste and still function quite well, and a new president with a fresh mandate should be able to eliminate the worst excesses if he chooses to do so. Meanwhile, the market and the actions of the Fed have reduced the likelihood that the credit crunch will result in a collapse of the financial system. Investors are buying up the dicey mortgages at a discount, and banks are raising new capital so they can return to the business of lending.

Most important, the credit and oil-price shocks are triggering needed reforms. Mortgage lenders will face new regulations, and banks new capital requirements. Consumers are switching en masse to more fuel-efficient vehicles and to public transport. And more and more voters are registering to let the current crop of politicians know what they think of them come November.