Signs of U.S. Economic Recovery are Overblown

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It is possible that the Fed Chairman’s optimism on economic recovery will be tempered by reality once the Senate has confirmed him for a second term.  Ben Bernanke himself must know that his credibility is a commodity too, and its value will be hard to recover if it is proven to be worthless. 

The U.S. economy is in the doldrums even if it is out of recession

The U.S. economy will remain in the doldrums even when it is out of recession

Bernanke, Administration officials and the media seem to be grabbing onto any economic indicators that might signal the recession is over.  Economic confidence has increased slightly and retail sales went up a little last month.  In the UK, the BBC has interpreted rising unemployment as a positive sign since joblessness tends to lag behind growth.  Yes, it does – but how do you know when you are in a lag? 

There is no solid data suggesting that the economy will start to expand at normal levels any time soon.  Even when the economy pulls out of recession, the President and his Congress are ensuring it will remain in the doldrums. 

Just over a week ago, the President was telling Congress, “thanks to the bold and decisive action we’ve taken since January, I can stand here with confidence and say that we have pulled this economy back from the brink.” 

Yet, for better or for worse, the Troubled Asset Relief Program or TARP was implemented under President Bush, not President Obama.  What would have happened to the financial markets absent this $700 billion Wall Street bailout is a matter for endless debate.  What is not in question is that the current incumbent came in afterwards. 

President Obama is responsible for the $787 billion spending package known as the American Recovery and Reinvestment Act of 2009, that was supposed to get the economy growing again.  Mr. Bernanke may believe that the economy is “technically” now out of recession but so far that is just speculation.  What we do know is that the President’s tax rebate (misleadingly sold to American voters as a tax “cut” for 95 per cent of Americans even though tax rates remained unchanged), like President Bush’s $152 billion “stimulus” a year earlier, had barely any impact on personal consumption even in the short-term.  If the economy is growing again, it is due to the private sector, not the President. 

The big question is what will happen to the U.S. economy over the coming years.  Can the U.S. return to annual growth rates of 3-4 per cent?  Will President Obama’s policies ultimately help the economy or act as a drag?

Housing policy was the root cause of the financial meltdown and the U.S. economy.   Congress mandated banks to provide mortgages to people who couldn’t afford them.  Forced to take on higher risks, the banks sold off the loans to spread the risk, with government entities Fannie Mae and Freddie Mac playing a central role.  This egalitarian policy was supposed to spread the wealth and instead it under capitalized banks and led to a financial collapse. 

For now, this problem appears to have gone away because the demand for mortgages from low income borrowers has declined.  However, as economic activity picks up, essentially the same rules will apply, which means the U.S. economy remains susceptible to a repeat performance.  These mandates should be repealed and Fannie and Freddie need to be shut down.  But don’t expect that to happen under this President or a Democratic Congress.  

Moreover, as the budget deficit rises to astronomic levels over the coming years, two significant negative consequences can be expected.  First, inflation will take off.  In addition to all the evils of inflation as savings lose their real value and real incomes stagnate and fall, this will also lead to higher interest rates, exacerbating problems in the housing market and reducing consumer spending power.  There will be pressure for cuts in public spending or tax increases.  No prizes for guessing which is most likely to be promoted by this President.  Also, expect inflation to lead to bigger problems for those lending institutions with a surfeit of fixed rate loans. 

As if this isn’t a bad enough combination, the second result of President Obama’s economic strategy will be a run on the dollar.  Fed Chairman Bernanke has so far won his gamble against this happening.  As the world’s reserve currency, if you bail on the greenback the value of your securities decline too.  But investors have recently shown an inclination to move into gold and commodities.  If a sustained recovery doesn’t take shape soon, this means that the dollar could quickly weaken.  A run on the dollar will make last year’s financial crisis look like a picnic.  Are investors poised to run away from the dollar? 

Add to all this the impact of rising gas prices, additional spending on health care, cap and trade, more restrictive labor laws and trade protectionism, and the balance of probabilities lies heavily with the economic pessimists.  Optimists may argue that the private sector can expand the U.S. economy despite all these factors – but why impose these challenges in the first place? 

Yes, the U.S. economy will soon register some small positive growth and therefore technically be out of recession.  Doubtless, President Obama will seek the credit and his cheerleaders in the media will oblige.  But the harsh reality is that the President’s policies are leading to stagflation - a combination of high unemployment and high inflation.  This is something we last saw in the 1970s and it wasn’t pretty.

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