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The American Engine Still Can

The Fed v. reality.

12:00 AM, Aug 14, 2010 • By IRWIN M. STELZER
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The American economy is in serious trouble, and the remaining weapons we have available to prevent a double dip are few indeed. We will try to avoid a long period of deflation of the sort that doomed Japan to a lost decade, but are not confident we can. That’s a free translation of what the Federal Reserve Board’s monetary policy committee said after last week’s meeting. Of course, central bankers are not so blunt. The Fed’s committee actually said that “the pace of recovery in output and employment has slowed in recent months.” The economy “remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit.Housing starts remain at a depressed level. Bank lending has continued to contract.”

The American Engine Still Can

The Fed could have mentioned:

♦ Revised economic data that show the recent recession to have been the worst of the post-war years.

♦ The slowdown in economic activity in China.

♦ The absence of any long-term plan to rein in the deficit.

♦ The possibility of a “shock” to the world banking system if Greece defaults on its sovereign debt as seems increasingly likely, or if any one of our several states finally drown in their own red ink.

♦ The negative effect of the increase in health care, energy costs, and taxes, the latter planned by President Obama for year-end.

♦ The 2.6 percent decline in already-depressed pending home sales in June, despite record-low mortgage rates.

♦ The 1.2 percent decline in factory sales, indicating that the manufacturing recovery might be stalling.

♦ The pile up in inventories of durable goods.

♦ The widest trade deficit since October 2008.

♦ And, perhaps most important of all, the increasing number of workers unemployed for so long that their skills are atrophying, while economic growth no longer seems to produce very many jobs, causing two-thirds of Americans to believe that the economy has further to fall.

The worse news is that the bad news cited above is only the tip of the iceberg: The lethal out-of-sight 90 percent is a more dangerous threat to the good ship Robust Recovery.

Start with the state of the nation’s finances. The federal deficit remains untamed, at 10 percent of GDP, topping the decade’s pre-Obama high of 3.5 percent in 2004. Given the slowing of the recovery, a reasonable argument can be made that what is needed is continued spending, but only if combined with a medium-term plan for bringing the deficit under control. No such plan is on the horizon, in part because of the political paralysis produced by the impending congressional elections, and in part because “kicking the can down the road” – leaving every problem to the next generation of politicians – has become a durable feature of American political life.

The second longer-term problem is the Obama-created imbalance between the private sector that creates wealth and the public sector that depends on that wealth. A recent analysis by USA Today, based on government compensation data, shows that federal government employees earn, on average, twice as much as private sector workers. That’s a result of the recent stagnation in private sector compensation and a steady rise in the pay of public sector workers. This situation was exacerbated earlier this week when Congress decided to spend $26 billion to prevent lay-offs of teachers and other state employees, funded in part by higher taxes on U.S. corporations that do business overseas. Teacher lay-offs, of course, are used by politicians to attract sympathy and bail-out money, rather than fire less useful workers in their over-manned bureaucracies.

Then there is the perverse incentive created by a badly structured tax system. A small businessman in New Jersey took to the op ed pages of the Wall Street Journal to point out that it costs him $74,000 to pay an employee $59,000 per year, when taxes and benefits are factored in. But when the employee pays her taxes, she is left with only $44,000. So the gap between his cost of hiring and her incentive to work is substantial. Not a prescription for full employment.

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