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Guarded Optimism for the Econo

Irwin M. Stelzer

Some attribute the recent spate of less-than-encouraging news about the U.S. economy to the  government shutdown, the battle over the debt ceiling, and to the reprise due in a relatively few weeks. They point to the decline in consumer confidence during and immediately after the shutdown: the Conference Board’s household confidence index plunged last week from 80.2 in September to 71.2, and the University of Michigan’s consumer sentiment index also dropped. Tellingly, the compilers of the Michigan index report that negative mention of the federal government was “the highest in more than a half-century of the surveys.”

Businessmen also profess themselves so rattled by the political turmoil that they are holding back on investing in new plants and equipment, and reluctant to add staff. The reluctance to hire is exacerbated by uncertainty surrounding the costs the implementation of Obamacare will impose on employers who have more than fifty workers, and fears that a new wave of regulations soon to be issued by the Environmental Protection Agency will drive up energy costs by making it impossible to burn coal in new power stations.

The unsatisfactory state of the labor market, along with the slow pace of the recovery, persuaded the Federal Reserve Board’s monetary policy committee to continue its bond purchases rather than “taper” as it was planning to do only a few months ago. The Fed’s gurus believe the unemployment rate is too high to allow them to slow the printing presses and, more important, that a continuing decline in the labor force participation rate bodes ill for the long-run future of economic growth and productivity. Over 90 million men and women over the age of 16 are not working—10 million more than were idle when President Obama took office. The private sector created an average of 129,000 jobs per month in the third quarter of this year, far below the 200,000 monthly average in the first half of the year. The Wall Street Journal put it this way, “For every three Americans over the age of 16 earning a paycheck there are two who aren’t even looking for a job.”

With Janet Yellen due to move into Ben Bernanke’s chair at the Fed, this situation will certainly lead to a continuation of QE3-the printing of money. There will be only two more job reports this year, one next week, the other early in December. Neither is likely to contain information so startling as to cause the Fed to roll back its bond purchases, which is why share prices are soaring, with the occasional downward jiggle. “Tapering is off the table for the foreseeable future,” says Andrew Law, head of Caxton Associates, the phenomenally successful money manager.

Early next year Yellen will be in charge, and she has made it clear that the unemployment situation is intolerable, that she firmly believes that loose monetary policy can create jobs, and that looser is better than merely loose. She has also made it clear that she does not feel bound by the Fed’s long-standing inflation target of 2 percent per year. She is not the only unbound economist these days. No less a figure than Harvard’s Kenneth Rogoff told the press that the Fed should push the inflation rate to 6 percent for a few years to boost the economy. Older economists who remember the chaos caused by Jimmy Carter’s stagflation-high inflation, no growth-are appalled. Younger ones view the Carter years as ancient history, with no relevance to present-day policy, and Japan’s deflationary “lost decade” as the example of the greater evil.    

The labor market is not the only trouble-spot in the economy. Some analysts worry that a great source of strength in recent months, the housing market, has peaked. The much-watched Standard & Poor’s/Case-Shiller index of house prices is now over 12 percent above last year’s level. But the increase in rates on standard thirty-year mortgages—from 3.54 percent in April to 4.47 percent in September—resulted in a drop in the sales of existing homes in September, and a plunge 5.6 percent in pending home sales (contracts signed). Higher house prices probably also contributed to the drop-buyers like to believe that prices will go up after they make their deals, but know that further double-digit increases are less likely now that the market has recovered from its lows.

To round out the bad news we have a decline in orders for durable goods (excluding the volatile aircraft sector) in September and a downward revision of August figures, and retailers’ resignation to a holiday season marked by heavy discounting, with some of the promotions scheduled to begin next weekend. Remember, the politicians have until right before Christmas to come up with a spending package, and right after the holidays to decide on an increase in the debt ceiling. The inevitable news stories during the run-up to a deal won’t do much to add to Christmas cheer.

Perhaps most worrying of all, if it is possible to worry about something more than the condition of the labor market, are two developments. The first is the decline in new business formation, to the record low reached in 2009. Commerce Department data show that the portion of businesses operating in the U.S. that are new ones-five years old or younger-has declined in recent years. If government policy is slowing the great American innovation machine, we are in for protracted slow growth.

The second worry is the persistent stagnation in middle class incomes and in upward mobility. The causes are complex. The Manhattan Institute’s Diana Furchtgott-Roth believes that allowing more parents to shop for alternatives to failed public schools is the best hope of getting more kids on the ladder to better incomes and lives. Other solutions are on offer, but that is for another column.

There: I have done my duty by those readers who tell me I am excessively optimistic about the outlook for the American economy, and my economist friends who challenge my credentials to practice the “dismal science.” I would urge them to balance these negatives against the longer-term positives.

America is becoming an energy giant, with cheap natural gas to fuel the factories of foreign investors. Silicon Valley firms and their counterparts that are springing up in cities around the country continue to develop world-class technology and products. Despite rising prices and interest rates, home affordability remains above its long-term average. Corporate profit margins and cash piles are high. And America’s immigration problem is that the world’s best and brightest, and its hardest working, are clamoring to live here. They might just be better forecasters of America’s economic future than worshippers of economic models. 

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