Tightrope walk­ing

The Washington Times Weekly - - Editorials -

Ape­riod of eco­nomic slug­gish­ness may soon ar­rive, with plenty of im­port for the 2008 elec­tion. Fed­eral Re­serve Chair­man Ben Ber­nanke warned Congress’ Joint Eco­nomic Com­mit­tee on Nov. 8 that the Fed “ex­pected the growth of eco­nomic ac­tiv­ity would slow no­tice­ably in the fourth quar­ter from its [an­nu­al­ized] third-quar­ter rate,” which the Com­merce De­part­ment re­ported to be 3.9 per­cent. Mr. Ber­nanke, who later in his tes­ti­mony ac­knowl­edged that he and the Fed had sig­nif­i­cantly un­der­es­ti­mated the depth of the on­go­ing hous­ing re­ces­sion, pro­jected that growth would re­main “slug­gish dur­ing the first part of next year.” He added that the Fed ex­pected the econ­omy to strengthen later next year “as the ef­fects of tighter credit and the hous­ing cor­rec­tion be­gan to wane.”

The Fed’s pro­jec­tion of a re­bound next year fol­low­ing an­tic­i­pated slug­gish­ness may be overly op­ti­mistic. For ex­am­ple, it seems at odds with Morgan Stan­ley’s eco­nomic fore­cast, which pre­dicts that the econ­omy will grow by an ane­mic 1.8 per­cent in 2008. Morgan Stan­ley re­cently ob­served that “ eal U.S. growth near zero over the next few months is pos­si­ble” — just as vot­ers head to the polls to se­lect pres­i­den­tial nom­i­nees.

On Oct. 31, fol­low­ing rel­a­tively pos­i­tive re­ports on eco­nomic growth and em­ploy­ment, the Fed low­ered its short-term tar­get in­ter­est rate by a quar­ter-per­cent­age point. That re­duc­tion, which fol­lowed Septem­ber’s ag­gres­sive half-per­cent­age-point cut, brought the fed­eral-funds rate to 4.75 per­cent. In his tes­ti­mony on Nov. 8, Mr. Ber­nanke hinted that the Fed was un­likely to lower this rate again this year.

When the Fed cut short-term rates so ag­gres­sively in Septem­ber, it did so in part be­cause non­farm em­ploy­ment had de­clined by 4,000 jobs in Au­gust, fol­low­ing lack­lus­ter em­ploy­ment growth of 69,000 jobs in June and 68,000 in July. How­ever, sub­se­quent re­vi­sions lifted job growth in July to 93,000 and re­versed Au­gust’s ini­tial job loss into a gain of about 90,000 jobs. The ini­tial Septem­ber em­ploy­ment re­port re­flected a gain of 110,000. This, then, was the em­ploy­ment sit­u­a­tion con­fronting the Fed at its Oct. 30-31 meet­ing: Re­cent em­ploy­ment growth cer­tainly wasn’t tor­rid, but it was tread­ing above pre­vi­ously re­ported lev­els that would have sig­naled a pos­si­ble re­ces­sion.

Also on Oct. 31, the Com­merce De­part­ment re­ported that gross do­mes­tic prod­uct (GDP) in­creased at an an­nual rate of 3.9 per­cent dur­ing the third quar­ter. How­ever, there is good rea­son to be­lieve that an un­usual quirk sig­nif­i­cantly un­der­stated the an­nu­al­ized in­crease in the third-quar­ter GDP price in­dex. The ef­fect of an un­der­state­ment in in­fla­tion would be to over­state real growth. The GDP price in­dex for the third quar­ter in­creased at an an­nual rate of only 0.8 per­cent, which seemed to defy re­al­ity. The last time this price in­dex rose slower than 0.8 per­cent in a quar­ter oc­curred in 1963. So, third-quar­ter growth was prob­a­bly over­stated by at least 1 per­cent­age point, per­haps more. In any event, as noted above, the Fed and private fore­cast­ers ex­pect an im­mi­nent slow­down.

Fi­nan­cial mar­kets re­main quite frag­ile, as the de­ba­cles at Mer­rill Lynch and Cit­i­group demon­strate. (And check out the “ABX cliff-div­ing” graphs at the Cal­cu­lated Risk blog.) Mean­while, as the dol­lar con­tin­ues to de­cline and the price of oil con­tin­ues to soar, in­fla­tion­ary pres­sures mount.

On Nov. 2, two days af­ter the Fed low­ered the overnight rate, the La­bor De­part­ment re­ported that the econ­omy gen­er­ated 166,000 new jobs in Oc­to­ber. How­ever, given the on­go­ing fragility in the fi­nan­cial mar­kets and the likely im­mi­nent slow­down, the Fed was right to ease a bit two weeks ago. But that in­sur­ance pol­icy con­tin­ues to ex­act a big toll on the dol­lar. The Fed re­mains perched on its tightrope.

The Repub­li­can Party is per­form­ing its own high-wire act. An elec­tion-year growth rate be­low 2 per­cent would likely be ac­com­pa­nied by a ris­ing un­em­ploy­ment rate. Con­gres­sional Repub­li­cans and the White House re­cently have been ec­static in hail­ing the “Bush boom,” even as prospec­tive vot­ers have been telling poll­sters that they trust Democrats more than Repub­li­cans to “do a bet­ter job” han­dling the econ­omy (50 per­cent to 35 per­cent), taxes (46 per­cent to 40 per­cent) and health care (54 per­cent to 29 per­cent), ac­cord­ing to the latest ABC News/Wash­ing­ton Post poll. A re­cent Pew poll re­vealed the big­gest two-party gap in 20 years (29 per­cent­age points: 54-25) as re­spon­dents said they be­lieved the Demo­cratic Party “is more con­cerned with the needs of peo­ple like me.”

There are good rea­sons for vot­ers to be cranky. As the 2007 Eco­nomic Re­port of the Pres­i­dent re­veals, me­dian fam­ily in­come (mea­sured in con­stant 2005 dol­lars) peaked at $57,508 in 2000 but lan­guished at $56,194 in 2005, the latest year for which data were avail­able (and the fourth year of the Bush ex­pan­sion). Mean­while, dur­ing the fifth year (2006) of the “boom,” me­dian earn­ings of full-time, year-round work­ers de­clined for the third year in a row for men and the fourth year in a row for women. A high-wire act in­deed.

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