Since September, the Fed has cut rates from 5.25% last September to 3.50% and it's poised to cut them an additional 25 basis points today. Moreover, the House last night passed a $146 billion economic stimulus package. The problem with all this is that with inflation raging and consumer spending weakening, the cure could be worse than the disease.
This sequence of events brings back memories of the chorus that led us into war in Iraq. We heard mournful dirges about Weapons of Mass Destruction (WMDs) and Saddam Hussein's ties to 9/11. The cresting of national fear unleashed a war that's killed almost 4,000 soldiers, over 80,000 Iraqis, and cost $1 trillion. Meanwhile, it turned out that the WMDs were an illusion created by Douglas Feith, a Cheney aide, and there was no Saddam Hussein tie to 9/11.
The beauty of creating a policy based on no evidence is that in the right hands this very lack of evidence can be spun to reinforce the need for the policy. The political genius of this White House is its ability to turn an argument's weakness -- the lack of evidence for a desired policy outcome -- into a strength. In the case of the liquidity measures, there is scant evidence of a recession. And that lack of evidence has been turned into the basis for all the rate cuts and stimulus.
A recession -- two quarters of negative GDP growth -- has not been measured yet. The third quarter showed GDP growth of 4.9%. Today, ADP reported that the U.S. added 130,000 jobs in January. And yesterday, there was another piece of evidence that the economy was doing just fine -- durable goods orders were up 5.2% in December.
So what is the basis for all these rate and tax cuts? Well, the economy appears to be slowing -- GDP grew a mere 0.6% in the fourth quarter but consumer spending -- which accounts for 70% of GDP growth -- was up 2%. The housing market is terrible -- but the U.S. economy has other industries besides housing many of which are doing pretty well. And the part of the financial markets that got involved with mortgages and securitization is taking a pretty big hit -- totaling in the tens of billions so far
But it appears that a $32.9 billion drop in business inventories accounted for a big chunk of the slowdown -- although the durable goods spike could be a good sign. Meanwhile, at 3.9%, inflation is running well above the Fed's 1% to 2% target -- making me wonder whether the economy is facing stagflation rather than recession.
This leaves me thinking that we've been talked into a recession without much evidence to back it up. What could be the motivation? Two words: legacy and 2008. The rate and tax cuts are intended to give Bush what he thinks of as bragging rights to overseeing a strong economy under his tenure -- that's the legacy part. And 2008 refers to the fact that this is an election year and giving voters checks prior to the election could help sway voters. (And since the package tilts towards those with incomes below $150,000, those checks might favor Democratic voters.)
If there is no recession, the White House will attribute the outcome to its rate and tax cuts. If there is a recession, the White House will tout those cuts for keeping it short and shallow. But these policies run the risk of increasing the Federal deficit, lowering the value of the dollar, and boosting inflation.
We don't hear much about Iraqi WMDs anymore but that won't bring our soldiers back to life or restore to our treasury the lost trillion spent on Iraq. That's the problem with this White House's policies, the reality of the mistakes are harder to erase than the illusion on which they were sold.
Are you experiencing a business slowdown? Are you facing unemployment? Is your house being foreclosed? Or are things going pretty well economically?
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter
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Reader Comments (Page 1 of 1)
1-30-2008 @ 12:20PM
densaw said...
Wow! You sound more like a Democrat than an economist. Let's see, could it be a recession, an economic slowdown, a normal downturn in economic cyles, or anything else one could call it? Maybe it's just a setup so large brokerages can buy the short term, knee jerk small investors stocks for near nothing, knowing we're probablay in for a terrific year in the markets. Whatever, it's just got to be George's fault, it just can't be anything else. By the way, who's fault was it when the economy was spiralling downward so fast and out of control during the last year of the Clinton administration?