The Fed's Dilemma
The fourth quarter GDP was worse than the “experts” expected. This will not be a surprise to readers of this blog, but what is surprising is that these same experts had expected that the weak dollar would help us grow our way out of a recession through surging exports. It didn’t happen.
The report showed that the growth in American exports slowed markedly during the third quarter, to 3.9 percent, down from 19.1 percent in the previous three months. Some economists have suggested that sales abroad could ultimately spare the economy from recession, as United States companies exploit a weak dollar and stronger growth prospects on foreign shores. The latest report punched a hole in that theory.
As I have tried to point out, the Laissez-Faire economics that have ruled Washington since Ronald Reagan’s inauguration have led to a hollowing out of America’s manufacturing capacity. We don’t make stuff the rest of the world wants (aside from Boeing airplanes and Digital Entertainment) and so it doesn’t really matter how much the dollar falls, export growth will not make up for falling domestic consumer demand.
The Fed will probably cut rates this afternoon, but my sense is that what ever they do, the market will be disappointed and sell off.
Bill Gross of Pimco, points out the extreme dilemma the economic stewards of our country face. Greenspan, Bill Clinton and George Bush tried to convince us that demand could always be created with easy money so we never had to fear a severe recession (sometimes called Depression).
Because demand in the form of consumption has been artificially and fictitiously stimulated in recent years by financial engineering run amuck, there is a legitimate question as to whether its black hole imploding destructiveness can be totally countered with another dose of lower yields and deficit spending packages. The $150 billion “return to sender” deficit plan advanced by Bush and the Congress, for instance, amounts to just 1% of GDP and is labeled temporary. It will be of marginal benefit to long-term prosperity.
Gross argues (along with Paul Krugman, Nouriel Roubini and myself) that the era of this artificial stimulation of the consumer is now over and that the supply side tools of the Reagan revolution are inappropriate to the coming crisis. The signs that consumer growth at all costs is an insane strategy can be seen in the problems of a company like Starbucks. Within five blocks on Montana Avenue in Santa Monica there are three Starbucks. This is called cannibalization and it will stop. I have argued that what needs to take the place of artificially stimulated consumption, is long term infrastructure investment. As Gross points out,
To provide a stable recovery path government spending needs to fill the gap – not consumption. Public works programs, badly needed infrastructure repairs, as well as spending on research and development projects should form the heart of our path to recovery. Assistance for homeowners? That too – figure out a fiscal/regulatory way to stop the slide in housing prices and foreclosures but please – no traffic jams at the Wal-Mart checkout counter in 2009 and beyond.
[...] I suggested this morning, there was nothing the Fed could do to satisfy Mr. [...]
Do the hundreds of $bn being spent on Iraq end up trickling back into the US economy? If so isn’t the government already undertaking a massive spend that isn’t having much of an effect?
Adam- My guess is the only pockets they have gone back into are Halliburton, Northrop-Grumman and the body armor companies. The record of large military companies being big job engines is way oversold.
Good post! I’m also concerned about other financial shananagins that have not come home to roost yet. The LBO boys have been buying up companies with very little down and valuing them in the billions – this can’t help our financial situation either.
It is already becoming clear to countries that they are trading in devalued ($) currency. Americans who have been drinking the cool aid will have to take some pretty bad medicine soon.
Cutting interest rates and causing the dollar to keep falling will lead to inflation when the imports have to rise in price. Pumping a devalued currency into the markets is a recipe for depression.
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