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Saturday, Aug. 13, 2011
Muddling as the economy sinks
The margin of error for the world's economic managers is shrinking. The United States is on the cusp of a double-dip recession, the eurozone flirts with collapse, Japan continues to struggle with deflation — a task made harder by the triple catastrophe of March 2011 — and global stock markets are on a roller-coaster ride.
Unemployment is mounting, debt is growing, and politicians seem unable to get the situation under control. Those leaders recognize the scope of the problem, but they do not seem able to act. Future historians are unlikely to judge them well.
The future of the euro has been at risk for months now as the aftereffects of the 2007-2008 global financial crisis continue to wash through Europe. Halfhearted attempts to clean up banks and government finances — two distinct problems that are nonetheless connected given the role of government revenues in keeping banks afloat — have ensured that problems have not gone away and in fact grown over time.
Each failure to wipe the slate clean — with all the attendant costs — only raises the price of an eventual solution, making such a deal even more unpalatable to politicians.
In the U.S., the fixation with government deficits and the intransigence of anti-tax zealots ensure that Washington is unable to create the demand needed to pull that economy out of its slump. Indeed, it looks as though many politicians in Washington actually prefer deadlock and paralysis.
The irresponsibility of those who seemingly welcome a default on U.S. obligations is beyond our comprehension. The resulting downgrade of the U.S. credit rating by S&P last weekend actually makes sense, even with its appalling mathematical errors. It is difficult to fault the judgment's political reasoning.
The uncertainties in the U.S. and European markets, along with Japan's enduring woes, make the stock markets' gyrations of the last week understandable. An estimated $5.4 trillion of wealth has evaporated since July 26.
What is not so clear is how, given that instability, policymakers seem unable to do more than signal a readiness to act and then do more of the same.
"More of the same" is the signal sent by the U.S. Federal Reserve's Open Market Committee, which decided earlier this week to hold short-term interest rates near zero through mid- 2013 — and nothing else.
Yes, growth "has been considerably slower" than expected, "the unemployment rate will decline only gradually," and there is little prospect for rapid improvement. Nevertheless, inflation hawks on the committee have managed to temper any enthusiasm for bold action that might provide the stimulus that the U.S. economy so badly needs.
Federal Reserve Chairman Ben Bernanke, a student of Japan's economic struggles during the 1990s and who should therefore understand the need to create demand in a stagnant economy, insists that the Fed is "prepared to take further steps if needed," but only if growth remained elusive — the U.S. economy grew an anemic 0.8 percent in the first half of this year — and if inflation was eliminated.
It is true that the Fed has limited tools to stimulate demand, but it could buy more Treasury bills (it already holds more than $2.5 trillion in Treasury and mortgage-backed securities; proceeds from those holdings are reinvested). This quantitative easing is controversial and a suboptimal solution, but at a time of government inaction it makes sense. Yet, the fear of inflation seems to prevail over the prospect of collapse.
Of course, it is not just the Fed that seems paralyzed. Finance ministers and central bankers from the G-7 leading economies held a conference call last week and pronounced themselves ready to "take all necessary measures to support financial stability and growth in a spirit of close cooperation and confidence."
For the most part, that translates into efforts to make sure that foreign currency markets remain stable, such as when Japanese authorities intervene to prevent the yen's value from soaring. The size of such markets means that single country intervention is likely to fail; only coordinated action can have the desired effect.
Ultimately, however, restoring confidence demands more than rhetoric. Applauding "decisive actions" by the U.S. and Europe to deal with their problems suggests that the G-7 ministers consider the steps those governments have taken to be sufficient.
The markets cast their own judgment on those actions by continuing to slide Monday, bouncing back Tuesday as traders sensed buying opportunities, and then dropping again Wednesday.
As one trader explained, markets reacted to the Fed's readiness to keep interest rates low and bought shares. But once they focused on the real message — that fundamentals are weak — stocks tanked again. And that reality is what matters. Politicians have yet to make the serious choices required to get economies back on their feet.
There is no single prescription: Stimulating demand makes sense in Japan and the U.S., but much of the problem is a shortage of demand. In Europe the problem is governments living beyond their means. A real recovery demands tough decisions — we have yet to see any of those.