Tuesday, August 09, 2011

US fiscal, money policy at a dead-end

Business Times - 10 Aug 2011

US fiscal, money policy at a dead-end

Political paralysis in Washington may put pressure on the Fed to help re-energise the economy and cut the jobless rate


AFTER a week dominated by a series of bad economic reports - ranging from the political deadlock on cutting national debt in Washington to the mounting financial crisis in the euro zone - it sounded like a piece of good economic news that should cheer up officials and investors: US unemployment has dropped.

Indeed, the US Labour Department report indicated that employers added more jobs in July than forecast, with payrolls rising by 117,000 workers after a 46,000 increase in June. Overall, the jobless rate fell to 9.1 per cent in July from 9.2 per cent in June.

But deconstructing these figures made it clear that what they signalled was not going to lift the spirits in Washington or on Wall Street. The-glass-is-half-full spinning of the numbers would be that jobless rate isn't as awful as expected. It could have been worse.

But then the drop in unemployment was mainly due to the fact that about 193,000 Americans left the workforce, with the share of eligible Americans holding a job declining to 58.1 per cent, the lowest since July 1983. Or to put it differently, more Americans were giving up on looking for employment, leading to the rise in underemployment.

Consumer spending

The measly job gains were certainly not going to bolster consumer spending that rose last quarter at the slowest pace in two years, spooking businesses and investors last week.

Moreover, with the overall economic growth reaching only 1.3 per cent in July, a historic low growth rate - and against the backdrop of the US federal debt muddle, the European sovereign debt disarray and Chinese inflation concerns - there are rising fears that the US economy may be headed for another recession. Actually, most Americans feel that they have yet to come out of the first recession that had officially ended a while ago. So it's not surprising, therefore, that pundits are starting to use the 'd' word - for double-dip recession.

The huge sell-off on Wall Street reflects similar sentiment among investors that the economic growth may be coming to a halt, and that the problems facing the American economy are long-term and structural - as opposed to the earlier consensus that assumed that temporary setbacks resulting from the earthquake and nuclear disaster in Japan and the upheaval in the Middle East were responsible for the anaemic economic recovery.

That the mood in Washington and on Wall Street is probably going to remain gloomy for a very long time is understandable. After ending their second round of quantitative easing (QE2), the heads of the Federal Reserve made it clear that it was running out of effective monetary tools to stimulate the economy.

The conventional wisdom in Washington was that the White House and Congress would now have to embrace a set of fiscal measures to help stimulate the economy while tackling the mounting federal deficits, a policy mix that could have included measures to induce economic growth (lowering payroll and corporate taxes; increasing US exports; rebuilding the nation's infrastructure) while approving a grand bipartisan and balanced plan to cut the deficit by restructuring the government-financed health insurance and retirement programmes and increasing revenues through taxation.

But in the aftermath of the nasty political and legislative debate in Washington over the extension of the government ceiling and the somewhat incoherent - and some would argue, impractical - deal that was reached between the White House and the Republican leadership in Congress, it is becoming clear that the politicians in Washington lack the power and the will to deal with America's long-term fiscal problems before the 2012 elections.

And while both Democrats and Republicans insist that the election would centre on the competing fiscal agendas of the two political parties, there is no reason to believe that the balance of power on Capitol Hill will change in any dramatic way and that the legislative stalemate would end after next November's vote.

Moreover, it is difficult to imagine how the current dysfunctional US government will be able to agree in the coming months on any major policy steps to help stimulate the economy, with the exception perhaps of an extension of the cuts in payroll taxes. With the Tea Party exerting so much influence on the congressional Republicans who now control the House of Representatives, the chances that lawmakers would approve even a modest economic stimulus programme are close to zero.

S&P's take

That bearish perspective is apparently shared by the credit rating agency Standard & Poor's which announced on Friday that it has cut its top, long-term rating from triple-A to AA+ for the US Treasury's debt. It was the first time the nation's rating has been lowered since the US won the top ranking in 1917.

'The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilise the government's medium-term debt dynamics,' S&P said in its report, stressing that the deficit reduction plan passed by Congress last week failed to stabilise the country's debt situation.

Take for example the legislation to approve free-trade agreements with South Korea, Colombia and Panama that the Obama administration has been promoting as part of its strategy to create new US jobs through the expansion of US exports.

The agreements have been languishing in Congress for several months as consequences of an inability to reach a deal on extending benefits for American workers displaced by foreign competition.

It is also important to remember that America's fiscal problems and the failure to accelerate economic growth are being exacerbated by the fiscal crises facing state and local governments where huge debts are forcing major cuts in spending, including in programmes to support retirement and healthcare and the laying off of thousands of government workers.

And the kind of fierce ideological debate between the Republicans and Democrats in Washington is taking place in state legislatures around the country and leading to the shutdown in many critical programmes that will not survive without assistance from the federal government.

The political paralysis in Washington may put pressure on Fed chairman Ben Bernanke and his colleagues whose policymaking committee will be holding a meeting this week to try to 'do something' in the monetary arena to try to re-energise the economy and reduce the unemployment rate. After all, the mandate of the US central bank includes both maintaining stable prices and maximum employment.

Partisan debate

And at a time when interest rates at an all-time low and prices are not rising beyond the 2 per cent rate that is regarded as safe, the Fed may emerge as the only player in Washington that could at least try to stimulate the economy and reduce unemployment.

But in order to play the role of job creator of the last resort, the Fed may have to consider the launch of another round of purchasing US Treasury bonds and expanding the money supply, or QE3.

But such a move could trigger opposition from the Republicans and their Tea Party allies on Capitol Hill who have argued that the Fed's expansive monetary policies are encouraging government waste, increasing its debt and lowering the value of the US dollar. That means that the US central bank would be forced into the middle of the bitter partisan debate in Washington.

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