Last week President Bush and Federal Reserve Chairman Ben Bernanke both expressed the view that the economy is not headed for recession. With the credit markets in turmoil, housing slumping badly, oil prices soaring, the dollar plummeting and inflation rearing its ugly head, how can they be so optimistic?
The reason is simple; they can’t afford not to be. An economy is nothing more than money in motion. If the money stops moving, the economy stalls. The key to the machine is consumer confidence. When people feel good about things they spend money. If they are afraid of tomorrow they stop buying. This means that the leaders in Washington can’t say, “the sky is falling,” even if it is.
If It Walks Like a Duck….
The reality is that words alone are not going to make people feel better. The average person is feeling the pain. There is pain at the pump, pain at the grocery store, pain just about everywhere. The collapse of home prices have caused people to perceive that they are not as well off as they were. Corporate layoffs lead to an uneasy feeling about their job security. People who are, or were, employed in the real estate industry are being hit especially hard. Words alone are not a balm for this ache.
The most recent economic expansion was fueled almost entirely by credit. Now that the credit party is over there is no fuel remaining to keep the economic engine running. People are feeling the crunch and they can no longer use their home as a personal piggy bank. Some people have stopped spending because they have nowhere left to get cash, while others are pulling back out of fear. The economy is grinding to a halt.
The Government’s Latest Folly
The Government’s answer to the economic downturn is to use a two-pronged attack to get the money in motion again. Step one is to aggressively lower interest rates in an effort to stimulate borrowing by easing credit. Isn’t that how we got into this mess in the first place? The second step is to provide an economic jump-start by putting money into the hands of the public. The idea is that they will spend it and the economy will heat up. Of course, if they don’t spend the money it doesn’t do any good. This is nothing more than a Band-Aid fix. The long-term consequences are enormous and we will pay much more in the end.
An Old Nemesis May Return
In a normal recession inflationary pressure tends to ease. Money is generally considered to be tight and lowering interest rates can have a stimulating effect. However lack of credit wasn’t the problem, too much was. Making credit easier is going to cause a significant jump in the rate of inflation. We are already seeing it in the price of gasoline. The interest rate cuts were a primary factor in dollar’s nosedive. The fall of the dollar causes the price of imported goods to rise and the majority of our oil is imported. Higher oil prices impact just about everything. Have you been to the grocery store lately? Prices seem to be climbing rapidly.
Couple this rise in inflation with a stagnant economy and you have the return of stagflation. Those who remember the Ford-Carter years know that this isn’t a good thing. If this downward spiral isn’t nipped in the bud there could be many years of pain ahead. Our economy, by its very nature, is extremely resilient. It has the ability to withstand almost anything if left alone. Unfortunately the Government always feels the need to do something. If only our elected officials could use some common medical wisdom: First, do no harm.
Government’s view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it. – Ronald Reagan