With a multitude of economic issues circling the globe – the Euro crisis, China’s economic slowdown, and the imminent systemic banking crisis – one of the main focus points on the US presidential election is how these issues will affect not only the US economy, but the global economy as well, since America is one of the largest economies in the world and spill-over effects are absolute.
There is however a growing concern that the US economy is going to be wrecked due to a mixture of bad politics and slowing global growth. Mitt Romney, President Obama’s rival, is using this to his advantage in the next presidential election. Since January, the Obama administration has been trying to keep the “show on the road” by creating more jobs and keeping growth positive as best they can, but due to numerous factors – such as slowing growth in China, the Euro crisis, an unemployment percentage which is still in double figures, and the Congress debate – their efforts may be deemed useless. If the situation’s outlook worsens (as it mostly did) the Fed will bring on a swift response, although this would make the current situation even more volatile. Republicans would be forced to decide to support the lesser of two evils: either to support fiscal props for the economy or cheap money supplied by the Fed. It really doesn’t matter how you look at it, it is going to come down to the Fed to decide how to salvage the situation.
Federal Reserve chief Ben Bernanke delivered a speech in Jackson Hole, Wyoming, and stated the economic situation is far from satisfactory. High rates of unemployment are still a major concern, not only because it is a waste of human talent but also because it will wreak structural damage to the economy that could take years to resolve. Another major concern highlighted by Bernanke is that there is no definite solution to the Euro crisis yet and fears are growing that it will drag the US back into recession. His fears were backed by figures indicating that unemployment remained at an all time high in July. Unemployment figures increased in July with 88 000, pushing the total Euro citizens unemployed to 18 million, the highest level since the monetary union in 1999. Bernanke continued by stating that any action taken by the Federal Reserve would trigger a furious response from within the Republican Party who has criticised his previous actions and has warned against any new actions taken by the Fed. Romney made it clear that he will replace Bernanke once he is elected due to an accusation made by Romney that the Fed is putting tax payers’ money at risk.
The House Financial Services Committee Chairman, Spencer Bachus, made a statement at a congressional hearing last month that the Fed cannot be held liable for any losses and cannot rescue the Americans from the consequences of failed economic regulatory policies passed by Congress. The Fed has stated on numerous occasions that it will do whatever it takes to stimulate growth and this has included measures to keep interest rates near zero until late 2014 and to start quantitative easing programmes. So questions arise, what has been done to try and rescue the Americans and why are there still no results?
A quantitative easing (QE) programme was started in November 2008 until May 2010 where the Fed bought $1.175tn in debt held by mortgage providers Fannie Mae and Freddie Mac. Although it did succeed in lowering interest rates, it failed to work completely as there is just too much debt in the country. Hence, another quantitative programme (QE2 or “Operations Twist”) was started in September 2011 where the Fed did a swap of $400bn in short-term loans form longer terms bonds. QE2 was also extended in June 2012 adding a further $267bn, but due to a lack in markets responses it had no impact on either interest rates or equity prices. There have been indications of starting another quantitative easing programme (QE3), but it is highly unlikely to be backed by the Fed before the election is over. The major problem of the failure of these programmes being successful in delivering promising results is based on the lack of market responses, and this has lead to an important indicator that monetary easing is no longer a useful tool to increase economic activity.
Moreover, it will be impossible for Feds to reduce long-term rates any further as it has lead to the fear of investors of a bubble in bond and stock prices. This could lead to a substantial market-driven rise in long-term rates which the Fed would be unable to stop. This could be easily triggered by investors’ portfolio preferences away from long-term bonds.
Some economists argue that the actions of the Fed have helped the owners of stocks and bonds, but it is unclear whether they have helped to stimulate economic activity. The US economy still has a slow growth pattern and unemployment is still in double digits. The US economy has expanded for 3 years; however GDP is still only 1% more than it was 5 years ago when the recession started, along with rising fears of a further decline in 2012. With regards to markets, business investment is low although MNC’s have large cash balances, thus there is still a major fear of investors losing their money. At the same time small businesses cannot get loans due to banks having inadequate capital and lower interest rates are not helping. Monetary easing contributed to a weak dollar, but most of the dollar’s decline has been reversed by capital flight from investors abandoning the euro.
There are however a few solutions highlighted by economists. The first solution would be to wait for the US Congress to come up with a policy move to help the economy rather than relying on the Fed all the time. The sharp rise in taxes that is scheduled to start in 2013 should be removed. The long-term fiscal deficit should be reversed by stemming the growth in transfer to middle-class retirees and the relationship between businesses and the government should be strengthened. This would lead to rising employment and the Fed can focus on its mandate of preventing a rise in inflation, otherwise it will be pointless.
David Page, a senior economist at Investec, stated that another solution would be for the Fed to invest cash received from maturing holdings of mortgage-backed bonds into fresh asset purchases rather that allowing the asset portfolio to shrink. This would lead to a more stable policy and could be the first step in a broader shift in policy.
Larry Elliot wrote a blog where he stated that the economy can be viewed as the living dead economy – the Euro zone that has not crashed but cannot be reformed; banks are kept alive by major quantities of electronic cash but does not lend; homeowners who are sitting in their homes worth less than when they bought them but are kept alive by low interest rates and lenders have no desire to crystallise losses; policies that is neither one thing nor the other.
One thing is certain; the Fed did as much as they could before the elections in November and it is undeniably clear that they will not do any more until the elections are over. Elliot went further by saying that the main problem for the economy being in the state it is, is that economic policy lacks coherence, monetary policy is governed by a belief for the need of unrestricted credit, and fiscal policy governed by a belief of expansionary contraction. He concluded by saying that the disaster is based on one major assumption; that if given time, the grown-ups will fix things. It is difficult to deny the truth in these words and 3 responses come to mind; fix it given time, use a different toolkit or it is impossible to fix due to the fact that the system is bust. It becomes clear that the solution is not an easy one and no horizon is yet in view behind this disaster.
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