Monday, February 16, 2009

Economic Policy: Where Do We Stand Now?

The economy won President Barak Obama his job and the economy is the focus of his agenda. Given the speed of events, it is not too early to assess the administration's economic policy and the key issues confronting us.

The administration's economic policy is a three legged stool. The first leg is the new bank rescue package; the second is its trade policy; and the third is the stimulus package. By the end of last week it already seemed a bit wobbly.

Treasury Secretary Timothy Geithner has the lead on the first two and he had a rough week.

Preventing a banking collapse is crucial. How do we prevent the debacle on Wall Street from destroying the banking system which must fund economic recovery? It was the collapse of the banking system that was the biggest reason an ordinary recession in 1929 turned into the Great Depression.

Geithner introduced the administration’s bank rescue plan on Tuesday and how did security markets react? They dropped like a rock. The stock market fell 4.6% in the first half hour after his speech was released. Bond prices fell. Markets around the world followed suit. Martin Wolf, the associate editor and chief economics commentator at the Financial Times (London), asked "Has Barack Obama’s presidency already failed?" Geithner’s plan lacked specifics and gave no indication that it would work.

Back to the drawing board.

The second leg is trade policy. Protectionism is a monster that must be caged. Trade is so crucial, but seems to be the most backburner of issues in the news. How do we avoid a return to the trade wars of the 1930s? The collapse of world trade was the second most important reason the 1929 recession turned into the Great Depression. The U.S. passed the Smoot-Hawley Tariff in 1930, Canada promptly retaliated before the law was even enacted. One nation after another tried to steal trade from the others by devaluing its currency and/or raising tariffs. As each tried to pull itself up by pulling down its mates, they all crashed to the floor. The nineteenth century's great age of globalization came to a final end. Will we learn from the past? For as Ben Franklin put it, "We must all hang together, gentlemen...else, we shall most assuredly hang separately."

America must lead the battle against protectionism. So far the new administration has been more a source of worry than leadership. As candidate Obama, the President advocated protecting American jobs on the campaign trail. That doesn't help. Congress tried loading the stimulus package with "Buy America" provisions. Even before being confirmed as the new Treasury Secretary, Geithner started out bashing China, but then had to backpedal when the finance ministers of the G-7 (i.e., the main economies) met in Rome. Peer pressure? After all, China's $581 billion stimulus package might do more to help slow the global downturn than Congress's many headed monster. Japan's decline at a double digit annual rate (see yesterday's posting) emphasizes how this is a global economic downturn with each country's decline feeding its falling domestic demand back to its trading partners.

And the third leg is the stimulus package: How do we get the economy jump started? Here the administration left the job of putting a stimulus package together to Congress, an institution whose approval ratings rank below those of former President Bush and used car dealers. The result is a package many people doubt will do the job but will blow up the deficit. It managed to unite the Republican opposition, no mean feat.

So even as the President basks in his Congressional victory on the stimulus package, his economic team is licking its wounds after a tough week. Managing economic policy is proving more difficult than campaigning against the status quo.

Monetary Policy: Meanwhile the Federal Reserve faces the daunting task of being ready to turn on a dime once (should I say "if") normality returns to financial markets. The explosion of the Fed's balance sheet poses major threats to its ability to conduct policy. When it turns the corner of the banking crisis and maybe sooner, the Fed faces the Sylla of a run on the dollar and the Charybdis of exploding inflation. That we should have a Ben Bernanke as Fed Chairman at this peculiar time and place seems providential. I do not envy him.

I must add Ben Bernanke to my ever lengthening list of causes to pray for.


Anonymous said...

Once again your observations are well presented and on-target!

The bank rescue plan was met with a resounding "thud" - as the Street expected to have details explained.

Not only was Geithner backpedaling on China trade, but Secretary of State Clinton was walking a thin line in her recent visit to China.

As we've discussed in the past, the monetary policy is crucial in the coming months (years?) in staying off inflation. Rather than trade protection, protecting the dollar should be the administration's primary concern.

Not addressed in any discussion I've seen yet is the ramifications of the housing bubble on county and local budgets. Fake gains have raised home values, and their resulting tax values. Unfortunately the mill levy will simply increase as the taxable value corrects.

Dr. Malcolm C. Harris, Sr. said...

Thanks for your comment.

Not all states will be affected equally. I doubt there was too much fluff in Kansas house prices. Supposedly house prices in this metropolitan area rose 30% over the last three years, but that is a fluke of the mix of houses reported in any given quarter and not necessarily a good estimate of the trend in house prices. The places hit hardest will no doubt be the Bostons, New Yorks, Miamis, and Californias: all those places covered by the Case-Shiller index where house prices doubled.

Before the last recession in 2001, we saw a surge in state and local government tax revenue in many states which led to a surge in state and local government spending. The inevitable hang over after the high tech bubble burst helped depress the national economy for two or three years.

I am sympathetic with the provisions of the stimulus bill that support state and local government spending. My worry is that the states will get hooked on it. I think that is precisely what I said on “Kansas Week” Friday night.