So, you know how it's supposed to grow? Really know?
No one "really" knows. Not you or me. That surely is one reason to keep one's fiscal house in order, which we most assuredly are not. Rather than me yakking, I will refer you to Stephen Roach, below, for reflections on what is going on economically that I agree with. He doesn't address the tax issue directly, he blames AG for this mess more than GWB, my opinion is both share the responsibility. AG, as Roach notes, is a political animal, if he got political support for doing the right thing, he would do it. I think.
Global: Stymied
Stephen Roach (New York)
March 8, 2003
America’s monetary policy conundrum is as excruciating as I can ever remember it. On the one hand, vigor from the standpoint of GDP growth begs for a normalization of short-term interest rates. Yet, at the same time, the lingering fragility of a jobless recovery argues for ongoing monetary accommodation. The Fed, in effect, is stymied -- caught in the cross-fire between the forces of inflation and deflation. For ever-frothy financial markets, that’s as good as it gets -- an opportunity to exploit a central bank that is frozen at the switch. Is there a way out?
The case for interest-rate normalization is grounded in one of the most basic principles of stabilization policy: Ammunition is to be used in bad times and then replenished in good times. Based on the Federal Reserve’s own assessment of recent and prospective vigor of US economic growth, it is now time to reload the monetary cannon. A failure to do so and keep the policy rate at 1% in nominal terms and “zero” in real terms is a recipe for a never-ending outbreak of asset bubbles. Early warning signs of such bubbles are now increasingly evident (see my 5 March dispatch, “A Time for Courage”). Largely for that reason, I have urged the Fed to raise the federal funds rate immediately to 3% (see “An Open Letter to Alan Greenspan” published in the March 1 edition of Newsweek International).
Yet the pitfalls of America’s jobless recovery -- a scenario I have long embraced -- seem to argue against such a policy shift. And once again, the consensus mantra of “hiring is just around the corner” has been dealt a cruel blow by the reality check of the monthly labor market surveys. February’s anemic pace of job creation (+21,000) plus downward revisions to the prior two months is just another in a long string of extraordinary disappointments on the hiring front. By our calculations, for a US economy that has now completed 27 months of so-called recovery, private nonfarm payrolls are running about 8.2 million workers below the path that would have been occurred in a more normal upturn. This hiring shortfall has led to an enormous leakage of wage income generation -- more than $400 billion in foregone growth in real wage and salary disbursements when this expansion is compared with the profile of the six prior cycles. Lacking in the internal support of earned labor income, consumers have drawn support from “toxic” sources of growth, such as open-ended tax cuts, reduced saving, extracting purchasing power from over-valued assts such as homes, and going deeply into debt to lever their assets. As long as the US remains hiring short and income deficient, goes the argument, a rate hike is the very last thing an overly-leveraged American consumer needs.
Then there is the political angle -- considerations that independent central banks are loathe to concede they ever contemplate. But they do, of course. After all, even central bankers can suffer from the humanlike faults of political animals. Two milestones in Alan Greenspan’s long career are especially noteworthy in that regard -- the first being an overly restrictive policy stance in 1991 that ended up being a serious complication in the failed re-election campaign of the first Bush Administration. The second came in the spring of 1997, on the heels of the March 25 rate hike that was aimed to tame the “irrational exuberance” of equity markets. Greenspan such took flak on this assault on markets, that he not only reversed course but then went on to preach a New-Economy message that effectively precluded any rate hikes for more than two years.
These considerations are very relevant in this year’s increasingly contentious election climate. My guess is that a politically-sensitive Fed will do everything in its power to avoid becoming an issue in America’s upcoming presidential campaign. That means that policy moves are likely to be avoided in the heat of electioneering -- namely, in the July 4 to November 2 window. That also means that any monetary tightening that needs to occur would have to be squeezed into the next three and a half months before the political window slams shut this summer. The latest employment survey certainly throws cold water on that possibility. Indeed, in the aftermath of this latest “surprise” on the jobs front, fixed income markets have moved to take out all but 40 bp of Fed tightening between and now and yearend -- a view our US team now endorses as well (see “Fed on Hold Until December” by Messrs. Berner and Greenlaw in today’s Global Economic Forum).
Largely for those reasons, the scales have tipped very much in favor of an accommodative Fed that delivers in accordance with both versions of its recent policy rhetoric -- in effect, remaining “patient for a considerable period.” For liquidity-driven financial markets, there’s no greater moment to seize. This is a classic “green light” for investors and speculators, alike. The persistence of a jobless recovery encourages the Fed all the more to let asset markets rip -- drawing on wealth effects in order to offset ever-anemic income effects as drivers of economic growth. Excess leverage is not judged to be important in a climate when the central bank is committed to underwriting low nominal interest rates for the foreseeable future.
None of this alleviates the concerns I have expressed recently about the increasingly reckless stance of the Fed. Sure, a monetary tightening at this juncture -- especially the outsize 200 bp move I have recommended -- runs the risk of a recessionary relapse. And it would also run very much against the grain of political correctness in this election year. But those are the tough choices that independent central banks need to make. In my view, the perils of another burst asset bubble far outweigh the costs of another recession. With only 100 bp left in its policy arsenal, the Fed is running a huge risk if it lets another asset bubble form. Yet no one seems to care -- even as bubbles now build in property and fixed in come markets (again, see my 5 March dispatch, “A Time for Courage”).
There is a way out of this mess, in my view. If the Fed is reluctant to tinker with its principal policy instrument, then it should give active consideration to secondary instruments that it has at its disposal. These include increasing margin requirements on equity lending, raising reserve requirements on real estate lending, and figuring out a way to challenge the “carry trades” that are currently taking fixed income markets to excess. America’s central bank is always hyper-defensive when suggestion such as this are made -- claiming that that there is little or no empirical evidence on the efficacy of such measures. It’s hard to accept the credibility of such assertions. Indeed, the minutes of FOMC meetings in the fall of 1996 show very clearly that Alan Greenspan knew full well that changes in margin requirements would bite (see my 27 February 2002 dispatch, “Smoking Gun”). And that’s precisely the point. In a low nominal interest rate climate, an asset-driven US economy needs to be put on notice that the central bank is still in charge. The signaling impact of asset-focused monetary tightening would go a long way in achieving this important objective, in my view.
The Fed needs to do more than play with words. America cannot afford to let its central bank be stymied by problems of its own making. This week marks the fourth anniversary of Nasdaq 5000 (a March 10 close of 5049). Have we learned anything?
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