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Reality Trumps Antics

12:00 AM, Apr 30, 2011 • By IRWIN M. STELZER
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People in nations with economic problems can be permitted to enjoy an occasional pause from contemplating their woes. Once there were circuses for diversion. Yesterday Great Britain chose a royal wedding as its relief from debt, benefits cuts, and taxes. And this week America was diverted by the antics of a property billionaire who claims to have been the one that forced President Obama to release his birth certificate to prove he was born in the good old U.S.A. The Brits arrange successions by insisting on royal lineage, we by insisting that candidates meet our constitutional requirement that they be born here.

Barack Obama

Britain will bask in the glow of “the kiss” over its long holiday weekend, which includes Monday. Here in America we return to hard reality on Monday, when Congress returns.

House prices continued their descent in February for the eighth consecutive month, reaching levels close to the April 2009 recession low, and are forecast to continue dropping for at least the rest of this year as sellers who have been holding out for higher prices capitulate to the market. Gasoline prices continue their ascent towards a national average of $4 per gallon, closer to $5 in some markets. This is a doubling since Obama took office, and a political problem for him. Voters are very sensitive to gasoline prices despite their relatively small portion of household budgets: they buy gasoline every week, stare at the pump meter as it spins ever more rapidly, and pass dozens of signs en route to and from work announcing the latest price increase.

As usual, a spurt in gasoline prices produces irrational reactions. The president proposes to bring them down by raising taxes on oil companies. How this will increase oil companies’ incentives to explore for and produce more oil is unclear. The fact is that there is very little the president can do about oil prices in the near-term as worldwide demand presses on supply. Oh yes, he could open large areas of the United States for drilling, but that would antagonize the oil company-haters and green voters on whom he is counting for support in next year’s election.

Meanwhile the dollar continues its fall as central banks around the world indicate they plan to raise interest rates while Federal Reserve Board chairman Ben Bernanke tells a press conference that he has no intention of allowing interest rates in the U.S. to rise any time soon. That divergence of policies makes foreign assets relatively more attractive—so sell dollars to get the currencies of nations offering higher returns. The chairman did promise to decommission the $600 billion bond buying program known as QE2 as scheduled in June. That should help to relieve the minds of those worried that the flood of newly printed dollars will add to inflationary pressure created by rising commodity prices. But it will antagonize those who believe that the last blow the fragile recovery needs is an end of monetary easing.

Bernanke also lowered the central bank’s forecast of this year’s economic growth rate to between 3.1 percent - 3.3 percent from the 3.4 percent - 3.9 percent it had predicted only a few months ago. He very substantially raised his forecast of headline inflation, but lowered the forecasted unemployment rate a tiny bit, the highest forecast for the 2012 election year now being 7.8 percent rather than the 7.9 percent projected in January. Proving once again that economists do use decimal points to prove they have a sense of humor: what new data could be so stunningly revealing to prompt grown men to make a 0.1 percent change in a forecast that is anyhow likely to be wrong is known only to the Fed’s economic modelers. No matter to the president: he needs unemployment to be below 8 percent when its campaign hits its peak next year, and 7.8 percent or 7.9 percent would suit his purpose.

In the longer run Bernanke is guessing that the unemployment rate will be somewhere between 5 percent and 6 percent. But recent data published by the Federal Reserve Bank of St. Louis call that figure into question. Economist Natalia Kolesnikova and research associate Yang Liu estimate that it would take monthly job growth of 350,000—the level in the 1990s—to hit Bernanke’s 5 percent target in four years. If the economy adds only about 200,000 jobs per month, approximately what it has been doing lately, it will take eleven years to reach the Fed chairman’s goal.

 

There is some reason to believe that job creation will pick up, something we will know after next week’s jobs report. Small businesses seem to be hiring at twice last year’s rate, larger firms have replaced layoffs with modest hiring, shortages of skilled workers in Silicon Valley are producing bidding wars, and auto output is up.

Whether the Fed’s decision to end its bond buying program will bring the current modest recovery to a halt, or its decision to keep interest rates down for the foreseeable future will more than offset the decision to stop the presses, is difficult to tell. One thing is certain: the center of gravity in political debate here in Washington has shifted. It is difficult to find anyone besides a few members of the hard-left of the Democratic Party, and some academics, who believe that the job of deficit cutting can long be postponed.

Meanwhile, when Congress returns, the debate over raising the debt ceiling will resume. The president, who voted against such an increase during his short stay in the Senate, wants it raised lest the credit of the U.S. be ruined by a default. The Republicans, who voted to raise it when George W. Bush was in the White House, want some sort of constraint on spending included in any decision to raise the ceiling, or else they will refuse to go along with an increase.

Both sides are predicting disaster if the ceiling is not raised. Which former George W. Bush treasury official Emil Henry Jr. points out is nonsense. “Since 1962,” he writes in theWall Street Journal, “the US has reached its debt ceiling 74 times, about once every eight months. Every time, the ceiling has been raised with little notice outside of Washington.” The government has frequently functioned after the ceiling has been reached—treasury officials are no less adept than those at major banks in finding spending that isn’t really spending for accounting purposes, or pockets of funds that can temporarily be tapped until the politicians work things out.

But the tactics that worked in the past might not work now. The day is long gone when no rating agency in its right mind would challenge the credit-worthiness of U.S. securities, when the bond vigilantes rode the pampas of Argentina and the steppes of Russia, but not the home of the world’s reserve currency.  

Better to escape these realities by watching Donald Trump do his comedy routine, examining the president’s birth certificate to determine its authenticity, than to worry about arcane debt-to-GDP ratios. For a few days at least. On Monday Congress returns, and reality bites. 

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