Don’t hit the panic button just yet. But keep it handy. Absent drastic, “and I mean drastic” spending cuts, and tax increases, and continued bond buying by the Federal Reserve Board to suppress interest rates on the federal debt, the U.S. will be unable to balance its budget. That’s the advice I got from Larry Lindsey, former Federal Reserve Board governor and White House economic adviser, when we discussed the current and prospective state of the political economy.

For now, the economy is on the mend. Despite the bleak jobs report, most analysts agree that it is gaining momentum. Profits are topping expectations, with fourth-quarter 2010 results up almost 30 percent on year-earlier levels. Exports are up and the agricultural sector is booming. The commercial property market, which President Obama’s favourite consumer protector Elizabeth Warren predicted last year faced a “tidal wave of … loan failures,” is now deemed by the Fed “increasingly unlikely” to experience that “worst-case scenario.” Consumer sentiment is at an eight-month high as personal income and spending continue to rise: American Express reports that customers increased spending by 15 percent in the final quarter of last year. Ford is planning to step up output by 13 percent this quarter, and despite higher gasoline prices its biggest and its most profitable vehicles, SUVs and trucks, are leading its comeback.

Better still, economists now expect average wage gains this year to almost double the 1.7 percent rate in 2010. And the demand for capital equipment has shown new strength in recent weeks as companies dip into their cash piles to pay for long-deferred replacement of obsolete equipment, and to finance expansion.

Yes, the housing market has yet to snap back. But the decline in house prices has made houses more affordable for those who can get loans, which an increasing number of buyers don’t seem to need – they are using cash. Fifty percent of recent sales in the Miami area were to cash-rich buyers, who drove prices up 15 percent last year. As usual, there are clouds on that cheery horizon. Analysts still expect prices to fall a bit further, and mortgage rates are edging up in response either to inflation fears or the recovery, or both. In the longer term any one of the plans to reduce the role of the government in the mortgage market will drive mortgage rates to a new, less subsidized plateau.

All of which has little to do with the reason for keeping the panic button handy. It’s the politics, stupid. President Obama says he is seeking a rapprochement with the business community, in part because he wants businesses to step up spending and hiring, in part because he knows that his reelection campaign will cost $1 billion, and he needs campaign contributions from the business elite he has spent the past two years demonizing. He is also having key Republicans around for lunch at the White House, the interior of which very few have seen since he took up residence there.

Alas, all this signifies not very much. The tension between the White House and the business community was hardly dissipated by Obama’s ostentatious stroll across the road from the White House to visit the Chamber of Commerce, its building festooned with a giant “JOBS” banner. His message: avoid big bonuses, share your perks with workers, and step up hiring. The alleged benefits of his economic policies, said the president, “Can’t just translate into greater profits and bonuses for those at the top.” Ever the champion of egalitarianism. Meanwhile, as Obama addressed the executives, calling for the patriotic cooperation he says their predecessors displayed in response to President Franklin Roosevelt’s call for cooperation in ending the depression – never mind that it took WWII to do that – his regulators continued to churn out cost-increasing regulations, which is one reason Republican budget-cutters have the Environmental Protection Agency clearly in their sights.

Worse still, the president and Republicans in Congress, now joined in driving the government machine, continue to disagree, with Obama stepping on the accelerator, and the Republicans in Congress attempting to jam on the brakes. Obama is locked in by the liberal base he needs to provide the energy for his reelection campaign, and continues to call for more government spending, or as he would put it, “investment” in everything from high-speed rail to solar panels.

The Republican leadership in Congress, locked in by Tea Partiers who say they were elected to cut spending and prevent tax increases, has little room to move. The leadership originally planned to call for holding spending to $35 billion below 2010 levels. When the newer members of the House raised an uproar, the plans were redrawn to call for an additional $26 billion in spending cuts. Even that is not enough of a cut, say the conservatives – “We have to go for significantly more,” announced Representative Jeff Flake of Arizona.

While Republican leaders cater to their right, the president will cater to his left when he presents his budget on Monday, a Valentine’s Day gift to those who believe deficit spending, even with the debt mountain at its current height, will bring down the unemployment rate. He will renew his call to let the Bush tax cuts expire for “the rich,” and back off his plan to curtail the increase in social security (pension) benefits. He will propose some spending cuts, but mostly in programs he knows Congress will in the end preserve, such as agricultural subsidies, near and dear to farm-state senators.

This dims any hope for compromises to reduce the unsustainable budget deficit. The president’s deficit-reduction commission made some sensible recommendations, but since it was set up by executive order rather than by congressional legislation, its suggestions were just that – suggestions with no binding force.

There is worse. Congressional Republicans, or many of them, believe that Federal Reserve Board chairman Ben Bernanke’s insistence on continuing the Fed’s $600 billion quantitative easing program – printing money – is taking America down the road to hyperinflation and a down rating of its sovereign debt. Last week Bernanke assured Congress that he would know when the economy was strong enough to allow him to reverse course, never mind the Fed’s less than perfect forecasting record. Until then, run the presses at a speed that has pushed the Fed pass China as the largest holder of U.S. IOUs.

So keep your finger poised. If the parties can’t reconcile their differences, and allow the federal deficit to continue at or close to double digits, if the Fed waits too long to stop the presses, if the 2012 elections don’t knock some sense into politicians’ heads, hit that panic button. The American economy might just become reacquainted with the gift once bestowed on it by Jimmy Carter: stagflation.

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