Dancing on Pins
Searching for a delicate balance.
12:00 AM, Jun 12, 2010 • By IRWIN M. STELZER
“We are all balloons dancing in a world of pins,” noted Sir Anthony Montague Browne, one of Winston Churchill’s private secretaries. That seems to describe our economic condition. Share prices drop like stones in response to actions by Greek civil servants, an oil spill in the Gulf of Mexico, an Israeli attempt to enforce its blockade against Hamas terrorists, or rumors that the Chinese regime is attempting to slow its economy. And then soar when Spain manages to borrow a few billion from unwary investors. Uncertainty is the order of the day.
Which makes life difficult for economic forecasters, who are more comfortable basing their effusions on non-random, hard data that point in one direction. That happy circumstance is denied to them.
Just when the housing market seemed to be stabilizing and the manufacturing sector to be recovering, along comes a report that only very few private sector jobs were created last month. Retailers, seeing sales drop by 1.2 percent in May, wonder just how much stuff to order in anticipation of the Christmas season. And just when the financial sector is preparing to hire large numbers of laid-off workers, a 2,000-page financial regulation bill introduces a nervous-making degree of uncertainty.
Equally important, just when the U.S. economy seems to be regaining its footing, news from long-ignored Europe turns gloomy. Retrenchment is the order of the day; Germany refuses to stimulate domestic demand; the European Central Bank declines to loosen monetary policy to offset the demand-stultifying effect of new austerity programs; and a shriveled euro threatens the export market for American goods.
Let me throw caution to the winds and try to cut a path through this jungle of conflicting data and random events. In doing that, it is always good to start with the chairman of the Federal Reserve Board, Ben Bernanke -- for two reasons. First, he has proven that he has a good fix on where the economy is headed, being more often right than wrong. Second, and equally important, his forecasts can be self-proving. If he thinks the economy is over-heating, he can cool it by raising interest rates and taking other measures to reduce support for banks, builders, and other economic players. If he thinks it needs a stimulus, he can provide one. He is not omnipotent, but he does have more power than most to make his forecasts come true.
Last week the Fed chairman told congress that the economy is improving across the country. Modestly, but improving. We have added an average of 140,000 new jobs per month in the past three months. He has no fear of inflation, which means he intends to keep interest rates low for the foreseeable future. Nor does he see the problems in Europe having more than a modest impact on America, barring a complete financial collapse.
Supporting that view are developments that promise to remove some of the uncertainty that is roiling markets. For better or worse, the financial reform bill will reach the president’s desk, and be signed. In the great American tradition, the financial community will wail and then learn to live with its provisions. The Europeans are inching towards a system that will make it more difficult in the future for members of euroland to engage in the sort of economizing with the truth, if not with public sector spending. Compensation systems are being re-crafted to reduce incentives for short-term profit-maximizing and the mispricing of risk. Banks will be required to have more capital, and in some countries to pay a tax so that in the event an institution fails and threatens systemic chaos, there will be funds available to bail it out -- the taxpayer will not be the first line of defense against a recurrence of the experience of recent years.
None of this is to say that we can see the future with great clarity, or that all of the dangers have been averted or are being attended to. Most important is the failure of our politicians to get our fiscal house in order, something that troubles the Fed chairman, who calls America’s fiscal condition “unsustainable.” Both the euro area and the U.S. will have debt-to-GDP ratios of around 100 percent by next year. In some ways, our national ledger is in every bit as bad shape as those of Club Med. Fortunately, as Bernanke points out, America is in “a uniquely favored position” because of the size of our economy and our deep and liquid financial markets.
There is talk in Washington that soon after the November congressional elections the president’s commission to reduce the deficit will come up with a combination of cuts in entitlement spending and increases in taxes, including some form of VAT. That will give Obama the occasion he needs to “pivot." If, as we now expect, the Democrats sustain heavy losses in the congressional race, the president will indeed pivot, and jettison profligacy for prudence, presenting himself to the electorate in 2012 as a born-again fiscal conservative. Ideology will not stand in the way of political survival. As Groucho Marx is reported to have said, “Those are my principles, and if you don’t like them … well, I have others.” Truly presidential.
Meanwhile, Bernanke, who says a double-dip recession “can’t be entirely ruled out,” will keep interest rates low. He wants to offset any budget tightening the president might be able to push through a Congress in which fiscally conservative Republicans have increased their presence, help the lagging jobs market to recover, give the economy a bit of boost should the sinking euro cut into U.S. exports, and buy some insurance against a major contagion rolling across the Atlantic. That might, just might, make his forecast that the U.S. will grow at an annual rate of 3.5 percent stand up to some of the harsher realities that have not yet been faced as the world economy pays the bills it ran up in the boom years.
In short, Bernanke knows we are dancing on pins, and wants to have some recourse should we get a bit too heavy-footed and burst a balloon or two.
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