Markets hate uncertainty, so the conventional wisdom goes. And it is true. But the reduction of uncertainty can be a mixed blessing, especially if what becomes more certain is likely to interfere with recovery from the recently ended recession.
Ben Bernanke has been confirmed for another term as chairman of the Federal Reserve Board. But confirmation came at a price -- the further dilution of the Fed’s independence. The leader of the Senate Democrats, Harry Reid, says that in return for his support Bernanke has promised to ease credit further. How that is possible with interest rates already effectively at zero, and printing presses working overtime to turn out dollars, is unclear. And it is unclear how the Fed chairman could have made such a promise while at the same time repeating his commitment to begin withdrawing central bank support from the mortgage market.
My own guess is that Bernanke will move gingerly to tighten, a little bit and not right away, even though inflationary expectations have risen from 2.25 percent in March to somewhat above 3 percent. He will keep a wary eye on the politicians upon whose favor and support he is increasingly dependent. Ignore them, and encourage the drive for legislation that will limit the Fed’s freedom of action in money markets.
Another uncertainty that has been dispelled concerns the president’s reaction to his party’s loss of the Massachusetts senate seat long occupied by Ted Kennedy. A similar setback prompted Bill Clinton to move from left to center -- the place on the political spectrum that is home to most voters. Not Barack Obama. In this week's State of the Union message he repeated the themes of his campaign and inaugural -- transformation of the health care and energy sectors, regulation of big banks, support for education, and economic stimulus, the latter relabeled as a jobs package. And he challenged his congressional colleagues to use their huge majorities in both Houses to pass his proposed legislation. A display of political courage, or of deafness to the expressed wishes of the electorate, depending on which side of the aisle you sit.
So we know that the era of big government is not over, as Bill Clinton claimed when he swung right after disastrous mid-term elections. Any doubts on that score were dispelled when the president announced his risible deficit reduction program. The annual deficit was reported last week to be $1.3 trillion. And it's rising. The president proposes to attack this elephant with a pop-gun -- a freeze on a tiny portion (17 percent) of the budget. In the unlikely event that unhappy liberals in Congress accept such a plan, it will cut spending by only $25 billion per year.
Meanwhile, legislation requested by the president and already approved by the House calls for new spending in excess of the projected savings. More spending on education subsidies, childcare benefits, infrastructure, subsidies for low-income mortgage holders and energy efficiency, funding of basic research in energy production, “a comprehensive energy and climate bill” certain to drive up energy costs -- a list that warmed the hearts of his congressional colleagues, or most of them. Throw in a second stimulus and $30 billion for small, regional banks, and it easy to see why Democrats who do not represent far-left constituencies such as House Speaker Nancy Pelosi’s San Francisco, fear they will have difficulty selling themselves as the guardians of the taxpayers’ purse when the mid-term elections roll around in November. And little wonder that the non-partisan Congressional Budget Office says the U.S. budget outlook is “bleak.”
So we now know that taxes will go up. Call it “fees” in the case of banks, or taxes on “the rich” in the case of income taxes, but up they will go. And swamp the tiny tax benefits the president plans to bestow on small businesses that “hire new workers or raise wages,” the latter not considered by most economists a sensible way to create jobs.
We know, too, that bank regulation will be tightened. The president, to the applause of Mervyn King, the governor of the Bank of England, wants to adopt the plan proposed by former Fed chairman and inflation slayer Paul Volcker. Banks that take customers’ deposits would be limited to plain vanilla lending, and their risk-taking subsidiaries spun off so that they can not again bring down the banking system. God is in the details, and since He has not been known to make His presence felt in the halls of Congress in order to preach sense to the sorts of politicians who seem to dominate the legislature these days, we will have to wait to see if this idea can result in sensible legislation.
All of which means we know that the future of the economy is now heavily dependent on what congress does with the president’s proposal to expand government intervention. It does seem as if a recovery is underway, and not only because the economy grew at the astonishing rate of 5.7 percent in the final quarter of last year. Businesses are once again investing in software and equipment, the inventory drawdown has ended and stocks are being rebuilt, investors are increasingly confident that the Fed’s withdrawal from support of the mortgage market will not cause a significant rise in interest rates, unsold inventories of new homes are at their lowest level in forty years, and consumer confidence has ticked up. And the economy grew at an annual rate of 5 percent in the last quarter of 2009.
But the recovery is fragile, and it can be aborted by the slightest policy slip. Increased taxes on “the rich,” which group includes most small businesses, will surely stifle expansion of the nation’s most important job-creating sector. If the Fed bows to panic-stricken congressmen and waits too long to tighten while the federal government continues pouring red ink over the nation’s ledgers, interest rates will surely rise, taking steam out of the recovery. If bank reform takes an ugly, populist turn, credit might become even less available than it is now.
These are big “ifs,” weighing heavily on market sentiment. But at least we know that it is policy that will determine the course of the economy in the near term, that the federal government is set on a tax-spend-borrow course, and that the central bank’s independence has been compromised. We might wish those things were not true, but they are. Reduced uncertainty, you see, is not always a blessing.
Irwin M. Stelzer is a contributing editor to THE WEEKLY STANDARD, director of economic policy studies at the Hudson Institute, and a columnist for the Sunday Times (London).