We Have Nothing to Fear But Fear Itself–Because Fear Means Under-investment, and Then Our Economy Stagnates

The Liberal Ironist would like to indulge in some intense pessimism: Our economic recovery is off-track, and there are several factors that could derail it outright.  None of these issues–as they stand–are sufficient to make the failure of the recovery inevitable, but each exposes us to risk of overproduction, rising interest rates, or significant inflation.

I should first aver that Federal Reserve Chairman Ben Bernanke actually expressed optimism about the economic outlook for the rest of 2011, saying that our fundamental economic indicators look strong and that the late-spring reversal of our economic recovery–the slight-but-depressing uptick in unemployment included–should be temporary.  The Federal Reserve Chairman is better-equipped to offer such a forecast than I, by virtue of his academic knowledge of the economy, his command of the facts (those being the facts that he considers normally in-point to issuing a half-year’s economic forecast) and his privileged access to confidential opinion by relevant policymakers in both business and government.

ARTICLE OF FAITH: Federal Reserve Chairman Ben Bernanke thinks our current economic slowdown should be temporary, a confluence of human-made disasters in the Middle East and a natural one in Japan. But in a social science, even a distinguished academic can't always see what's coming--especially if he isn't looking directly at it. Photo by Chip Somodevilla/Getty Images North America.

That said, Economics is a positivistic academic discipline, and the appointed chairman of a major institution speaks with discretion.  Knowing how reactionary investors can be–for no reason other than that they have to beat the overreaction they suspect others might be prone to–the Federal Reserve Chairman isn’t likely to say “Granted, there are a few really big ‘kill switches’ wired to the recovery right now, and someone is just bound to trip over 1–or several.”  So, here is a confluence of trends which risk dragging on the recovery:

President Obama’s stimulus wasn’t big-enough, and we won’t be getting any more.  The Liberal Ironist has long-agreed with Paul Krugman that the chief problem with President Obama’s 2009 economic stimulus was that it wasn’t big-enough.  But even in light of the massive Republican wave election in 2010, it would have been nice if current levels of Federal domestic discretionary spending–including some grants to the States to balance their budgets–could have been maintained.  The reason this would have been nice is simple: Our well-capitalized private sector, for whatever reason, has not seen fit to invest in more domestic production capacity while unemployment hovers in the 9% range.  Here House Speaker John Boehner (R-OH) hasn’t exactly risen to the occasion, uttering one of the least-explicable bits of economic dogmatism I have ever heard: “You’ve heard me say time and time again that we’ve got to cut spending if we’re serious about creating an environment for job creators in America to do what they do best–and that’s to create jobs.”  The Liberal Ironist has never heard anyone explain how cutting government spending–in many cases necessitating the termination of Federal or contractor employees, or compelling State or municipal governments that lose grants to terminate more workers–helps private companies create jobs.  It’s true that budget deficits can become a problem if a government has no long-term means to pay them, and that problem can only be addressed by budget cuts or through tax increases that could stifle business development, but no part of that reality explains how cutting government spending–especially with a large magic number of sorts in mind–could plausibly encourage private-sector job creation in the short- or intermediate-term.  But the massive shift of voter support and thus political initiative (intermittently reflected in recent nationwide opinion surveys) in favor of the Republicans has made President Obama’s achievement of his remaining priorities–mixing spending cuts with elimination of certain tax breaks and the end of the Bush income tax cut for the wealthy, along with increased spending on transportation infrastructure, research and development, and education–much harder if not impossible.  The idea of encouraging economic growth during a period of sustained economic downturn by steeply cutting government spending even defies common sense–and Congressional Republicans can’t bring our yearly Federal deficits under control without including tax increases in a budget plan, which Republicans have ruled-out as unacceptable.  In effect Congressional Republicans propose sacrificing our economic turnaround to strike a blow against big government.

OBAMA AND KEYNES: PERFECT TOGETHA. President Obama promoted a large economic stimulus plan in early 2009 which headed-off a depression but didn't justify the level of productive activity needed to put millions of Americans back to work. Rather than conclude that the stimulus was insufficient or that more-targeted Federal spending is in order, Congressional Republicans have embraced the curious view that a recession is a good time to drastically-cut Federal spending. Lord Keynes is spinning in his grave--which makes him about as productive as the US economy is going to be if too many relied-upon Federal programs wind up getting the ax. Photo is a composite: Salon/Reuters/AP, credit Salon.com.

The domestic housing market is cooling-off again.  Maybe I should rephrase that: “The housing market is retreating from anemic back to comatose.”  The real estate situation is grim even in comparison to the jobs situation.  Janet Yellen, Vice Chairman of the Federal Reserve, yesterday admitted that she “can envision no quick or easy solutions for the problems still afflicting the housing market” and that “recovery in the housing market likely will be a long, drawn-out process.”  She added that there were about 2 million vacant homes in the United States in the 1st quarter of 2011–many of them foreclosures, many of them pre-built models in surplus subdivisions that no one has ever lived in, and many of them simply abandoned.  This is bad news for recent homebuyers who made a bet that they could trade-up in what has already been a multiyear down housing market, bad news for homeowners who leveraged their mortgages to pay for major investments such as college for the kids, bad news for the construction industry, and obviously bad news for land developers and real estate agents.  It’s bad news for banks that continue to accept large numbers of foreclosed homes while market values are already depressed and there are few buyers, forcing the banks to pay taxes on properties they have no use for.  (Yes, this rolling mass of foreclosures victimizes banks as well.)  It’s bad news for municipal governments, whether townships, cities, or counties–as well as public school, police, and fire districts–as they are often supported by somewhat-regressive but usually fairly-stable property taxes.  A February article in the Washington Examiner portended hard times when it noted a tumble in commercial real estate values in Arlington County and the City of Alexandria in Virginia, affluent suburbs of Washington, DC inside the Capital Beltway.  (That the real estate market in our nation’s capital experienced such a shock ahead of the current Federal budget cuts suggests either truly pervasive stagnation in real estate or profound pessimism within the business community.)  The Bloomberg news article on this story further reported that 20 American cities currently have median home prices at their lowest level since 2003, and that economist Robert Schiller warns we should be prepared for further declines in home prices of 10%-25% over the next 5 years.  SmartMoney.com advised that “if employment creation remains low, risks of a double dip in housing naturally increase” in an article dated October 6, 2010.  At that time, the official US unemployment rate was 9.6%; in May it up-ticked slightly from the recent low to 9.1% according to the U.S. Bureau of Labor Statistics.  This is a good time to buy a house if you won’t need to sell it and you don’t need the equity; however, a year or 2 from now might be an even better time to buy.

Ouch--and this was the forecast over a year ago. Map courtesy of The Real Deal Online.

There is this slight but growing chance that…the United States Government will default on its debt.  This would be bad.  The astonishing part is that, unlike the rest of the current risk factors for a return to recession, a Federal Government default on its debt service would be the sole result of unintelligent choice, a self-inflicted wound.  The traditional opposition sermonizing about a lack of leadership aside, nothing aside from Congressional Republicans’ current Tea Party-driven aversion to authorizing an increase in the Federal debt limit even makes this an issue; the United States Government has never defaulted on its debt before.  There had certainly already been grumblings about raising the Federal debt limit by Tea Partiers, but I think the trouble officially got started when former Minnesota Governor Tim Pawlenty, now a Presidential candidate, wrote in a January op-ed in the Washington Post that the vote to increase the Federal debt limit would be a golden opportunity to force President Obama to accept drastic reductions in Federal entitlement spending.  A few months later, freshman Senator Patrick Toomey (R-PA) gave us assurances–based on the same hypothetical as Pawlenty’s op-ed–that even if Congress ran-out the clock on raising the Federal debt limit, Congress could still direct the Secretary of the Treasury to pay the interest on the Federal debt 1st, and proceed to fund or cut other needs 2nd.  Dana Milbank helpfully pointed out that if Congress failed to raise the Federal debt limit and Treasury prioritized Federal debt service in austerity budgeting, “even if we shut down the military and stopped writing Social Security checks, the government would still come up about $200 billion short.”  A default on Federal debt would plunge our economy right back into recession-easily.  Interest rates would rise substantially for everyone, as creditors would both be wary of debtors’ viability in general after the failure of the largest and most-reliable debtor, and would look to shore-up their capital through high-interest lending.  Meanwhile, holders of US currency reserves might abandon the US Dollar in droves if the government that prints them defaulted, thus making the currency drastically lose value.  Thus, during a prolonged period of economic stagnation, we would also face high inflation.

Stagflation.

THERE'S A LOT RIDING ON THIS GAME, GUYS: President Obama has invited Speaker Boehner for a round of golf, at which time the 2 will try to work-out common ground on a long-term deficit-reduction plan so that the increase in the Federal debt limit can pass. No, I'm not making this up. Composite photo: Carolyn Kaster (AP)/Douglas Graham (Roll Call).

The Initial Eurozone bailout of Greece didn’t work–and again, political preferences leave no clear path to restore confidence in the Euro.  One bright spot in this story is that the Federal Democratic Republic of Germany has consented to a 2nd bailout for Greece.  (As a Liberal ironist, I generally try to avoid referring to countries as if they were monolithic entities; I don’t like to talk about “America” as an agent because, unlike the United States Government proper, America is a continent-wide expanse of hundreds of millions of people who generally live and let live but whom have very different agendas and some profound differences in their moral beliefs.  Also as a Liberal ironist, however, my principles provide for exceptions, and as it is unfortunately far from clear who wasn’t complicit in government corruption and waste there I am left to say: “The Federal Democratic Republic of Germany has bailed-out Greece.”)  Note that the REUTERS article I have linked to indicates only that the European Union and the International Monetary Fund are the managing entities in Greece’s 2nd bailout; on the other hand the German government (as both the European Union’s largest economy and the current carrier of Europe’s hopes for an economic recovery) was apparently both the decisive agent of consent and the on-point information-broker for Greece’s new bailout and fiscal-restructuring deal.  This paternalism of the smaller European Union economies by the largest is the problem with the Eurozone as currently-conceived: Integrating most of Western Europe’s national economies with a single currency without standardizing those governments’ fiscal and economic policies led to corruptingly-low interest rates in Greece and Ireland and, according to Paul Krugman, a local inflation trap in Spain.  (For lack of a better word, “corruptingly” is now a word.)  So, falling interest rates encouraged peripheral governments to vastly over-leverage during the mid-Aughts boom; rising (Euro-driven) inflation in Spain, according to Krugman, led to a large international trade deficit that left both the public and the private sectors with a lot of debt once the international financial system crashed.  This divorce of organization-wide monetary from state fiscal and economic policy both facilitated perverse behaviors by some state actors, then punished both perverse and responsible state actors.  To operate without such hazards, the Eurozone should probably impose stricter control over the fiscal and economic policies of member states; frustratingly, however, these reforms are probably untenable at present precisely because of the inevitable growth of Euroskepticism in response to the costly bad behavior of Greek and Irish governments and financial institutions.  According to the Washington Post, Germany’s relatively-strong economic recovery also seems to have slowed, in part perhaps because of concern about Germany’s level of liability for damaged peripheral Eurozone economies but also, the article suggests, because of so many European governments’ reliance on mid-downturn austerity measures.

As goes the price of oil, so goes the price of pretty-much everything else in the World.  Consider the vicious cycle we’ve witnessed: The price of oil increases, which causes the price of food to increase because of mass agriculture’s reliance on the efficiency of oil-based synthetic fertilizers and pesticides.  The unavailability of food provokes riots in the Middle East, which topples some governments, destabilizes and divides others, and sends a panic through all of them.  Naturally, this causes the price of oil to rise.  (Incidentally, Libya produced only about 2% of worldwide oil for the open market last year, but it happens to produce a relatively-clean grade of oil very close to Europe.  The result is that many of Europe’s older oil refineries are disproportionately-reliant on access to Libyan-grade oil, which must now be substituted with oil from more-reliable but also more-distant sources.  As a result, the Libyan Civil War has had a disproportionate effect on the price of oil–not just due to media amplification, but because it has generated a logistical problem.)  In any case, higher oil prices definitely make despotic middle-income countries that don’t have a lot of oil far less-stable.  Considering the interspersion of oil-poor countries such as Tunisia, Egypt, Yemen, Syria and Bahrain around the oil-rich Middle Eastern countries, OPEC’s mostly-despotic member states might find it prudent to (somehow) lighten the load for everyone else.

For all our sakes, watch where you're shooting, Reds. REUTERS file photo.

Remember the March 11th Tōhoku Earthquake and Sendai Tsunami, and the triple full-core meltdown at Fukushima I nuclear power plant?  The news cycle has moved on from Japan’s great disaster (as, to his shame, has the Liberal Ironist–a neglect of a massive story which I hope to rectify soon), but it takes a while to reaally take stock of a natural disaster that will likely cost around $235 billion for repairs and which probably cost the lives of over 23,000 Japanese.  (This is part of why I didn’t say more about it earlier.)  As the Federal Reserve Chairman acknowledged in his recent address, this enormous disaster significantly undermined the economic recovery, though the rebuilding might prove beneficial to the Japanese economy.  After all, there will now be significant public- and private-sector investment in rebuilding and improving damaged infrastructure–investment that might otherwise go abroad–and this redevelopment will put people to work at a difficult time–though they might otherwise have been employed to manufacture goods or provide services for Japan’s major trading partners.

You didn't expect an event of this magnitude to harm our economic recovery? Where did you think these containers were being shipped? Photograph by Itsuo Inouye, Associated Press.

China’s economic growth might prove Icarian.  This is a big one, and the Chinese Communist Party has been on the watch for hyperinflation for a long time; however, neither the generality of the theory which suggests that a widespread improvement in the standard of living can lead to a politically-volatile increase in the cost of basic goods and services nor the motivation of the fully-consolidated Chinese Communist Party necessarily means that the People’s Republic of China will take the right course of action to prevent inflation from wreaking economic and then political chaos.  In fact, it isn’t even certain that China’s government has the power to stop inflation from hitting its fast-growing economy hard at some point in the near-future.

…Of course, maybe the Liberal Ironist is wrong and the Federal Reserve Chairman is right, and later this year the US economy will overcome this May sickness and our well-capitalized corporations will start employing new workers, increasing production and offering new services to renewed foreign and domestic consumer markets.  Until that point, however, our economy will be tailed by several prospective assailants (one of which is Congressional Republicans), several of which could strike.

I just hope the other sectors of our economy don’t have to wait on the housing market.

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2 thoughts on “We Have Nothing to Fear But Fear Itself–Because Fear Means Under-investment, and Then Our Economy Stagnates

  1. Kukri

    1) http://www.vanityfair.com/business/features/2010/10/greeks-bearing-bonds-201010

    Always a good time to re-post the amazing and anger-inducing story on the top-to-bottom corruption of the Greek government and Greek society. Damn straight the EU should couple a bailout with calls for immediate and significant reforms, while at the same time publicly praising and supporting the Herculean task of Greek’s socialist yet highly pragmatic Papandreou government.

    2) “this redevelopment will put people to work at a difficult time–though they might otherwise have been employed to manufacture goods or provide services for Japan’s major trading partners.” Glad you were able to recognize and therefore not fall for the “broken window” economic fallacy.

    Reply
  2. Pingback: Nicholas Kristof Offers a Model for Our Safety Net | The Liberal Ironist

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