Tuesday, January 22, 2008

And bad economic news

Business Times - 22 Jan 2008

Business Times - 24 Jan 2008

Cutting rates like it's an election year


THE decision by the Federal Open Market Committee (FOMC) on Tuesday to lower its target for the federal funds rate 75 basis points to 3.5 per cent is probably only the first in a series of such cuts by the policy arm of the US central bank. This is the largest cut since 1982 when it started using cuts to the federal funds rate as a primary policy tool.

The Fed chief Ben Bernanke and his colleagues on the FOMC have already cut the funds rate by 1.75 percentage points since last year and most observers expect the central bank to embrace another cut of 25 basis points at the scheduled FOMC meeting next week and to continue cutting rates to 2.5 or even two percentage points by the end of this year.

If the conditions in the markets continue to deteriorate there is a possibility that the FOMC will cut rates by half a percentage point next week.

The surprise move by the Federal Reserve, whose policymakers video-conferred on Monday, ahead of its normal meeting next week (Jan 29-30) is seen as a response to the anxiety in the American and global financial markets in face of a deteriorating US economy and indications that it is about to slip into a recession.

In fact, the growing consensus in Washington and Wall Street is that the recession is already here and that the economic stimulus plan proposed by US President George W Bush last week - a bipartisan version of it is expected to be passed by Congress very soon - is not going to make a dramatic difference in terms of the downward pressures on the economy.

Based on the reactions by financial markets around the world on Monday it seems that that is also the view shared by investors worldwide.

US home prices are expected to decline by as much as 20 per cent this year, which could have a major impact on American consumers. There have already been reports about decline in spending and rise in personal bankruptcies.

At the same time, there have been major concerns in the financial markets about possible deterioration in the condition of the companies that insure municipal bonds and other financial vehicles. But the decisions made by Mr Bernanke should not only be seen as a response to the drying-up of liquidity that could devastate American businesses and damage financial markets.

That the Fed chairman previously served as chairman of President Bush's Council of Economic Advisers (CEA) and is a veteran Washington operator has also to be taken into consideration. The political conditions in the US capital and around the country have certainly been factored into the decision.

The US is in the midst of what is seen as an historic presidential election campaign, and a painful and long recession this year would make it almost impossible for the Republicans to regain control of the White House and Congress and may provide the Democrats with an opportunity to score dramatic electoral victories.

Hence, ensuring that the economic recession will be short and mild in its effect on the American consumers/voters fits very much with the political agenda of President George W Bush and the Republicans.

At the same time, among the Republican candidates, the deteriorating economic conditions could certainly play into the hands of former Massachusetts governor Mitt Romney and weaken the position of another candidate, Senator John McCain.

As a very successful former business executive, Mr Romney has been promoting himself as someone who could manage the US economy. Mr McCain, a former Vietnam War prisoner, is accentuating his credentials as a national security leader at a time when the voters seem to be more worried about their jobs and mortgages and less about terrorism or the mess in Iraq.

Copyright © 2007 Singapore Press Holdings Ltd. All rights reserved.

Stimulus package may worsen US deficits

Combined monetary and fiscal measures could erode the dollar further and spark inflation


YOU are depressed and exhausted. But then you are injected with that feel-good package of goodies, 'a shot in the arm', and...voila, you are stimulated and you feel vigorous again.

I'm referring to the economic 'stimulus' package that US President George W Bush introduced last Friday. Another version of the package will be proposed by the Democrats this week, as part of an effort to head off an economic recession, and make American consumers and businesses - exhausted economically by the housing mess, the credit crunch, the rising oil prices, the stagnant job growth and the bearish stock markets - feel vigorous again.

Speaking from the White House with Vice-President Dick Cheney and Treasury Secretary Henry Paulson standing next to him, President Bush called for a US$145 billion stimulus package consisting mostly of tax breaks for consumers and businesses, which is expected to put as much as US$800 in the pocket of each American taxpayer by next year.

'By passing an effective growth package quickly, we can provide a shot in the arm to keep a fundamentally strong economy healthy,' President Bush said.

President Bush and his Republican allies believe that the White House's proposed broad-based tax relief should be big enough - about one per cent of the US gross domestic product (GDP) - to make a difference by pumping money into the economy right away. Their plan reflects basic Keynesian economic principles, suggesting that tax incentives for businesses will encourage them to make new investments, and that direct and rapid income tax relief for individuals will encourage them to increase spending at a time when people might otherwise spend less.

In a way, as some Republicans see it, the tax rebate to American consumers would help offset the effect of the rise in energy prices that amount to a form of additional tax.

The members of the Democratic opposition also subscribe to these Keynesian principles and have responded favourably to President Bush's proposals. But they also want to see increases in government spending on programmes that could help individuals and families who have suffered as a result of the recent economic problems and assist in creating new jobs.

In particular, the Democrats want to extend unemployment benefits and boost food aid for the poor as part of the proposed stimulus package. The administration has been reluctant to support increase in government spending for such social programmes.

But notwithstanding the differences that exist between the Republicans and the Democrats over the content of the stimulus package - Republicans want to see more tax cuts while Democrats call for more government spending - most observers expect that President Bush's proposals will serve as a basis for an agreement with the Democratic leaders in Congress that could be reached in a few days.

The willingness of the White House and the Democratic-controlled Congress to work together in a bi-partisan fashion reflects their recognition that the American public wants them to 'do something' ASAP to prevent a recession.

President Bush removed what would have been a big political obstacle to any deal on a stimulus package by agreeing not to include in it a demand that the tax cuts passed by Congress become permanent, an idea which the Democrats had rejected.

Almost all economists expect the American economy to slow down in the first half of 2008. The question is whether this slowdown would turn into a full-blown recession. The hope in Washington and on Wall Street is that a combination of interest rate cuts by the Fed and expansionary fiscal policy, including tax cuts and government spending, could help prevent a severe economic recession.

In addition to their economic impact, these policies authored by the White House, Congress and Fed could have a psychological effect by containing the vicious circle in which the fall in house prices and other financial problems accelerate the economic downturn. It would also encourage consumers and investors to continue spending and investing.

But there are also concerns among officials, lawmakers and investors that the economic stimulus plan may be coming too late to affect the economy, especially if one considers the political and legislative realities in Washington that would ensure that the proposed tax cut would not take effect until later in the year.

Moreover, much of the problems facing the American economy today resulted from the fact that consumers and businesses continue to spend beyond their means - thanks to the interest rate cuts by the Fed and the tax cuts and spending by the administration - and in the process helped create the mushrooming deficits.

The tax-rebates cheques mailed to American families would amount to a form of government spending if, as expected, the low-income Americans who will receive them spend them right away. Hence, together with the Democrats' proposed new federal government spending on social programmes, the stimulus package will expand the federal deficit that is under more pressure because of the spending on the continuing war in Iraq, and which will probably continue to grow if a Democratic president and Congress are elected in November.

Hence the combined monetary and fiscal policies could end up increasing the twin deficits - the current account deficit and the fiscal deficit - which could continue eroding the value of the US dollar. All of which also raises the possibility that inflation will raise its ugly head, especially as energy and food prices continue to rise.


Washington Correspondent

Copyright © 2007 Singapore Press Holdings Ltd. All rights reserved.

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