Sunday Times (London)
June 13, 2010
by Irwin Stelzer
We are all of us balloons dancing in a world of pins, noted Sir Anthony Montague Browne, one of Winston Churchill’s private secretaries. That seems to describe our economic condition. Share prices drop like stones in response to action by Greek civil servants, or an oil spill in the Gulf of Mexico, or an Israeli attempt to enforce its blockade against Hamas, or rumours that the Chinese regime is attempting to slow its economy. And then soar when Spain manages to borrow a few billion from unwary investors. Uncertainty is the order of the day.
Which makes life difficult for economic forecasters, who are more comfortable basing their effusions on non-random, hard data that point in one direction. That happy circumstance is denied them.
Just when the housing market seemed to be stabilising and the manufacturing sector to be recovering, along comes a report that only very few private-sector jobs were created last month. Retailers, seeing sales drop 1.2% in May, wonder just how much stuff they should order in anticipation of the Christmas season. And just when the financial sector is preparing to hire large numbers of laid-off workers, a 2,000-page financial regulation bill introduces an unnerving degree of uncertainty.
Equally important, just when the American economy seems to be regaining its footing, news from Europe turns gloomy. Retrenchment is the order of the day; Germany refuses to stimulate domestic demand; the European Central Bank declines to loosen monetary policy to offset the new austerity programmes; and a shrivelled euro threatens the export market for American goods.
Let me throw caution to the wind and try to cut a path through these conflicting data and random events. In doing that, it is always good to start with the chairman of the Federal Reserve Board, Ben Bernanke — for two reasons. First, he has proved that he has a good fix on where the economy is headed, being more often right than wrong. Second, his forecasts can be self-fulfilling. If he thinks the economy is over-heating, he can raise interest rates and take measures to reduce support for banks, builders and other economic players. If he thinks it needs a stimulus, he can provide one. He is not omnipotent, but he does have more power than most to make his forecasts come true.
Last week the Fed chairman told Congress the economy is improving across the country — modestly, but improving. We have added an average of 140,000 new jobs a month in the past three months. He has no fear of inflation, which means he intends to keep interest rates low for the foreseeable future. Nor does he see the problems in Europe having more than a modest impact on America, barring a complete financial collapse.
Supporting that view are developments that promise to remove some of the market uncertainty. For better or worse, the financial reform bill will reach President Barack Obama’s desk and be signed. In the great American tradition, the financial community will wail but then learn to live with it.
The Europeans are inching towards a system that will make it more difficult in the future for members of euroland to engage in economising with the truth, if not with public-sector spending. Compensation systems are being recrafted to reduce incentives for short-term profit-maximising and the mispricing of risk. Banks will be required to have more capital and in some countries to pay a tax so that, if an institution fails and threatens systemic chaos, there will be funds available to bail it out — the taxpayer will not be the first line of defence against a recurrence of the experience of recent years.
None of this is to say that we can see the future with great clarity, or that all of the dangers have been averted or are being attended to. Most important is the failure of our politicians to get America’s fiscal house in order, something that troubles the Fed chairman, who calls it “unsustainable”. By next year both the eurozone and America will have debts that are about the same as their gross domestic products. In some ways, our national ledger is in every bit as bad shape as those of southern Europe. Fortunately, as Bernanke points out, America is in “a uniquely favoured position” because of the size of our economy and our deep and liquid financial markets.
There is talk in Washington that soon after the November congressional elections the president’s commission to reduce the deficit will come up with a combination of cuts in entitlement spending and increases in taxes, including some form of Vat. That will give Obama the occasion he needs to “pivot”, as he calls changing course. If, as we now expect, the Democrats sustain heavy losses in the congressional race, the president will indeed pivot, and jettison profligacy for prudence, presenting himself to the electorate in 2012 as a born-again fiscal conservative. Ideology will not stand in the way of political survival. As Groucho Marx is reported to have said, “Those are my principles, and if you don’t like them ... well, I have others.” Truly presidential.
Meanwhile, Bernanke, who says a double-dip recession “can’t be entirely ruled out”, will keep interest rates low. He wants to offset any budget tightening the president might be able to push through a Congress in which fiscally conservative Republicans have increased their presence, help the lagging jobs market to recover, give the economy a bit of a boost should the sinking euro cut into American exports, and buy some insurance against contagion rolling across the Atlantic.
That might, just might, make his forecast that the US will grow at an annual rate of 3.5% stand up to some of the harsher realities that have not yet been faced as the world economy pays the bills it ran up in the boom years.
In short, Bernanke knows we are dancing on pins, and wants to have some recourse should we get a bit too heavy-footed and burst a balloon or two.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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