"Bewitched, bothered and bewildered," warbled Ella Fitzgerald, among others. That old song, written in 1940 by Lorenz Hart and Richard Rogers, just about describes what is going on in the American economy. When seven of the seventeen officials of the Federal Reserve Board dissent from the chairman’s decision to keep the Fed’s $2.05 trillion pile of mortgages and U.S. Treasuries from shrinking, uncertainty takes on a new meaning. Ten want to set the stage for printing more money, seven think enough is enough.
Fed chairman Ben Bernanke used the platform of the gathering of central bankers in Jackson Hole yesterday to attempt to reassure markets by promising additional monetary stimulus if it is needed. But he also confessed that “fiscal stimulus … can drive recovery only temporarily” -- in the end, it is up to consumers and businesses to create demand for goods and services. Worse, he confessed that the Fed had misread the mortgage market and allowed developments “inconsistent” with the Fed’s intention to keep policy loose. Makes one wonder if the Fed really has a grip on things.
For investors, uncertainty is the way station to fear. If those Fed experts can’t agree, we can forgive investors for being so unsure of what is next in store for the economy that they flee from shares to the safety -- alleged safety, say some -- of U.S. treasuries, despite their extraordinarily low yields. Never mind that earnings have been surprisingly good. All it takes is some bad economic news, and investors put their cash where it yields almost no return at all -- but is “safe.”
And of bad news there is more than enough. The economy, it turns out, grew at an annual rate of only 1.6 percent in the second quarter, rather than 2.4 percent as originally estimated. That means that the growth rate in the most recent three quarters has dropped steadily, from 5.0 percent at the end of 2009 to 3.7 percent and 1.6 percent in the first two quarters of this year.
Both consumers and businessmen are sitting on the sidelines. The July drop in sales of new (-32 percent year-on-year) and existing homes (-26 percent) to record-low levels exceeded even the gloomiest expectations, and can no longer be blamed on the expiration of the Homebuyer Tax Credit. Low mortgage rates seem to be offset by tighter credit standards, job insecurity is being fuelled by rising initial claims for unemployment insurance, and buyers feel it pays to wait because prices will be lower tomorrow.
Potential homebuyers are not the only squeamish economic actors. Capital goods orders, excluding defense spending and the 76 percent increase in the volatile aircraft segment, fell 8 percent, the biggest drop since January 2009. This “highlight[s] the risk of a significant slowdown of investment spending,” concludes Bernd Weidensteiner of Commerzbank. American corporations seem to be using some of their $2 trillion in idle cash to return to the acquisitions market, bad news for job seekers since successful acquisitions usually mean lay-offs in the acquired companies -- “efficiencies” and “cost savings” are the preferred description.
Add to this bad news an even more powerful drag on the economy: uncertainty. Bernanke says the Fed is loading its monetary policy gun by keeping its balance sheet from shrinking, but no one knows whether or when he will pull the trigger. Besides, even if he does, recent history suggests that the Fed can’t lure enough money from the wallets of debt-burdened consumers or from corporate treasuries to put the economy on a solid growth path. Mike Dude, CEO of vaunted retailer Wal-Mart, says, “The slow economic recovery will continue to affect our customers, and we expect they will remain cautious about spending.” Students are being made to do with their old PCs, and affluent fashionistas are eyeing lower-priced editions of their favorite designers’ lines.
There is worse. Large swathes of the economy are now subject to political rather than market forces. Health insurers are allowed to charge premiums that include only 20 percent for administration and profit, the balance to be spent on reimbursing medical costs of their policy holders. But no one yet knows for sure whether regulators will cram into the 20 percent lots of cost items so as to reduce the profits component. It is rumored, for example, that the cost of preventive care will be classified as “administrative” and come out of the insurance companies’ hide. And medical device manufacturers can only guess at the effect of the new tax -- $20 billion over 10 years -- on sales of and profits from everything from bed pans to surgical instruments. They do seem certain about one thing: the tax will cut into export sales.
Then there is the financial services sector. Earlier this summer New York’s banks and related financial-service providers began hiring. But now Wall Streeters fear they will once again be forced to trek from their office buildings, wilted potted plants in one hand, personal effects in the other, heading for the unemployment insurance line. Little wonder: regulators are busy drawing up the estimated 10,000 regulations needed to implement the 2,319-page financial reform bill. Just which businesses the major banks will be permitted to retain, what fees they will be allowed to charge, and what compensation they will be permitted to offer remain unknown. Not a recipe for investing in expansion.
The housing sector is also hostage to government policy. Potential buyers do not know what their after-tax incomes will be in the future because congress hasn’t decided whether to allow the Bush tax cuts to expire. They do not know whether they can count on continued low mortgage rates because they do not know whether Freddie Mac and Fannie Mae, the two taxpayer-owned agencies that account for almost all new mortgages, will survive the current policy review. These are enough unknowns to paralyze even the bravest potential buyer.
Finally, we come to the energy sector. Utilities have no idea what penalties will be imposed if they construct new fossil-fuel plants, mining companies don’t know what market there will be for coal if congress enacts an energy bill, and oil companies haven’t been told what regulations will be imposed on off-shore drilling. The only things that are known are that taxpayers will pay for subsidies to wind, sun and other forms of power generation that are not economically competitive, and consumers will pay more for electricity as their utility suppliers are forced to construct transmission lines to remote windy and sunny places.
Data from the Commerce Department’s Bureau of Economic Analysis, provided by my Hudson Institute colleague Diana Furchtgott-Roth, show that the health care, housing, financial services, and energy sectors account for well over one-third of U.S. GDP. That’s a lot of firms hesitating to invest.
Meanwhile, the president and Congress initiate still more spending, despite a soaring deficit and the fact that the trillion-dollar stimulus seems not to have lowered the unemployment rate by very much, if at all. One can’t help but be reminded of the thought attributed to Albert Einstein: “Insanity is doing the same thing over and over again expecting different results.” Or, as Rogers and Hart put it, “Burned a lot … and now you’re broke … [and] bewitched, bothered and bewildered.”