August 5, 2011
by Irwin Stelzer
None. That's the total of on-the-other-hand good news I have to report this week. Lest you think I am overlooking the debt deal cut in Washington last week, consider this:
? The deal did not prevent default, because default was never going to happen: The Treasury had plenty of cash with which to pay interest due on our debt, and would only have had to prioritise other payments.
? The deal will not reduce America's debt. The debt ceiling has been increased by $2.4 trillion, and that will only hold us into 2013. The so-called spending cuts are reductions in the scheduled increase in discretionary spending. Americans will wake up ten years from now another decade older and deeper in debt.
? Current projections of future deficit reduction are based on the heroic assumption that the economy will grow at an annual rate in excess of 3 percent this year—an impossibility given the miserable first half of the year. Forecasts for future years rise steadily into the 4 percent range. Those projections by the Congressional Budget Office and the Office of Management and Budget are up for review next week, and revisions will undoubtedly result in lower estimates of tax revenues, higher estimates of such costs as unemployment compensation, and an increase of trillions in the projected 10-year deficit.
? The deal does not assure that America will not be downgraded: The cuts are too small and there is no provision for producing a long-term sensible fiscal policy. [UPDATE: The deal did not prevent downgrade: The cuts were too small and there is no provision to produce the long-term sensible policy that Standard & Poor's is demanding.]
? The deal did nothing to restore confidence in the American political/economic system. Christine Lagarde, new head of the International Monetary Fund, says that the fiasco that preceded the deal is "probably chipping into that very positive bias … towards the United States of America, towards Treasury bills." Vladimir Putin accused America of living like "a parasite"—a charge that would have President Obama and Treasury Secretary Timothy Geithner sentenced to the Gulag in the good old days of the Soviet Union. And the Chinese regime, eager to find an alternative to treasuries in which to stash the trillions in the ill gotten gains of their policy of currency manipulation but unable to do so, accused the U.S. of destabilizing the international economic system, while Dagong, its rating agency, downgraded U.S. securities to A, the rating it assigns Russia, South Africa, and Estonia.
That's just one bit of bad news. Here's more.
The economy couldn't manage even one percent growth in the first half of the year, and most forecasters are scrambling to lower their forecasts for the rest of this year and next. Share prices are dropping like a stone. The manufacturing sector, until recently a source of growth, has lost steam, with new orders declining, a bad omen for the second half of the year. The service sector "has shown a clear loss of momentum," say economists at Goldman Sachs. Consumer spending in June dropped by the largest percentage in two years, as wages and salaries fell and consumers stepped up their saving rate against the day when they might have to join their aunts, uncles, and neighbours on the unemployment queue.
Paradoxically, all of this is made worse by the debt deal, which tightens fiscal policy in the short-run, and leaves the future of the nation's finances in a some-day-we-will-do-something stage. Tightening now, loosening down the road: The precise opposite of what a staggering, debt-ridden economy needs. Some economists estimate that the deal will cut between 0.1 percent and 0.3 percent off growth next year. But since no Congress can promise that some future Congress won't reverse any spending constraints the current members agree on, there seems no sure way credibly to promise that the next Congress will not resume its stroll down the path to national penury. Those who believe that a constitutional balanced budget amendment will do the trick should recall congressional ingenuity—the cost of the recent census, mandated in the Constitution, was declared an unexpected emergency by a Congress intent on piercing a spending ceiling.
Throw in the eurozone crisis. Even though American financial institutions are less at risk than their European counterparts to the fallout from this solvency crisis and the incoherent response of the eurocracy, talk of another Lehman Brothers-style upheaval has investors here on edge. With some reason: we have recently realized that U.S. money market funds are indeed important lenders to European banks. Whether relief at the announcement that the European Central Bank will support Italian bonds proves durable, it is too early to tell. My guess is that reality will overtake this gesture before too long.
Which brings us to the most watched statistic of all, the jobs report—watched not only by economists but by politicians who are wondering just how heavy a millstone around President Obama's neck the jobs situation will prove to be in next year's election. Friday's report that 117,000 new jobs had been created in July, that the unemployment rate ticked down from 9.2 percent to 9.1 percent, and that May and June figures have been revised upwards a bit, is in the dodged-the-bullet category—a report that could have been worse is not a good report. Fewer than 60 percent of adults are in work, the lowest figure for almost three decades, and 44.4 percent of the unemployed, over six million people, have been unemployed for six months or longer. Some 25 million workers are looking for a job, too discouraged to do so, or involuntarily working short hours. And here's really bad news: Economists at the Lindsey Group, who know their way around these data, say "the labor market is probably far worse than this morning's headlines indicate."
The economy's struggles are focusing attention on possible fixes. There is talk of the "additional policy support" that Federal Reserve Board chairman Ben Bernanke promised would be available if the economy weakened. But he is constrained by the facts that inflation is running above the Fed's preferred rate, and that the Fed approaches its August 9 meeting with few arrows left in its quiver. It could, of course, launch QE3, as several former Fed officials are urging. But it is more likely that it will state its intention to keep interest near zero for close to forever, and tilt its portfolio towards longer-term treasuries in an effort to drive down long-term interest rates. Any major new policy pronouncements will be held in abeyance at least until the gathering of the world's central bankers in Jackson Hole, Wyoming, later this summer—if then.
The president is off on a bus tour of the Midwestern states, and is expected to announce a few initiatives—extending unemployment insurance and the reduction in payroll taxes, higher taxes on "the rich." His former economic adviser, Larry Summers, and many of Obama's supporters in Congress want him to launch a new stimulus program built around infrastructure construction, but the Tea Party has shifted the debate to cutting rather than increasing spending, and the success of the last stimulus program is, at best, limited. If the president were a fan of Frank Sinatra, he might send Summers the recording in which Sinatra croons, "Everybody has the right to be wrong at least once [but] …only fools go walking on thin ice twice."
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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