AMERICA IS TOO TETHERED TO TAKE OFF / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( A MUST READ )

America is too tethered to take off

By Clive Crook

Published: June 5 2011 20:36

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Concern is growing that the US is falling back into recession. Consumers are scared. The housing market is crippled, with prices still falling. Last week saw more disappointing figures on jobs and manufacturing. Friday’s closely watched payroll numbers were worse than expected.

Analysts had predicted 175,000 new private sector jobs, which would have been low; there were 83,000. The unemployment rate rose to 9.1 per cent.

 

Within weeks, federal borrowing will collide with the statutory debt ceiling, raising the possibility of default; talks to prevent this are getting nowhere. The Federal Reserve’s second programme of quantitative easing, or QE2, is at an end. Higher commodity prices have caused a blip in inflation. All these factors should have lowered the price of US government debt, pushing long-term interest rates higher. But such is the concern about the flagging recovery that 10-year rates fell to less than 3 per cent last week, lower than they have been all year.

Even with a government that worked, remedial action would be hard to devise. Fiscal and monetary policy are both stretched, the options for more action limited and risky.

But the very notion of optimal policy just now is Utopian because the US does not have a government that works. If it did, the clock would not be ticking down to a congressionally mandated default even as the economy stalls.

Though asking the question is no more than an academic exercise, what ought US fiscal policy to do? It should combine renewed short-term stimulus (in forms that subsidise jobs) with measures to reduce borrowing (revenue increases and entitlement reforms) in the longer term. How could something so obvious be controversial? In a way, in fact, there is no controversy: Democrats and Republicans are agreed in rejecting this out of hand.

To the exclusion of every other consideration, Republicans want to cut spending as deeply and quickly as possible, adding to the risk of a second recession. For them, further short-term stimulus is out of the question.

Democrats, on the other hand, recoil at the idea of long-term fiscal control. This is camouflage, they think, for dismantling Medicare (health insurance for the elderly) and Social Security (pensions). Once you start worrying about long-term deficits, they say, you have conceded half the argument to the other side. In Washington, you concede nothing.

Democrats are right that zeal to cut spending immediately is dangerous, but they are wrong – wrong on the economics and wrong on the politics – that long-term borrowing can be left to take care of itself. On the present fiscal trajectory, even the US will exhaust its capacity to borrow. As for the politics, the Democrats’ complacency over public debt has moved opinion behind the Grand Old Party’s drive to cut spending immediately. Partly thanks to the Democrats, a position that deserves little support actually commands plenty.

By holding their respective views so implacably, the two sides have ruled out using long-term fiscal consolidation to make room for new stimulus. And the parties’ respective positions on taxes only compound the problem.

Republicans refuse to consider tax increases of any kind – even as part of a reform that would lower marginal tax rates. Democrats have also promised not to raise taxes for 98 per cent of households. Higher taxes on households making more than $250,000 a year is almost their only recommendation for deficit control, and that is plainly insufficient to deal with the long-term problem. Neither side has any interest in the profile of public borrowing over time – which is the fiscal variable that matters most.

It is probably too late to revisit these arguments. Positions are too deeply entrenched. Success in the debt ceiling talks has come to mean avoiding, for the time being, the calamity of a self-inflicted default. Once you filter out the noise, getting fiscal policy right in a more intelligent sense is not even being discussed.

That leaves, first, housing policy. Housing has been at the centre of the recession and it continues to blight the recovery. The market, unable to deal promptly with the surge in foreclosures, has failed to find its floor and stabilise. Even now, the administration should revisit this issue and look for ways to reduce and/or expedite foreclosures, either by taking them out of loan servicers’ hands or by giving distressed borrowers new options for reducing principal.

And then there is monetary policy. The Fed is divided on how far the risk of higher inflation argues for caution in maintaining, let alone increasing, the monetary stimulus provided by very low short-term interest rates and quantitative easing. Markets had come to assume there would be no QE3 when the present phase of easing ends: the only question was how quickly QE2 would be unwound.

The stalling recovery, and the evident incapacity of Congress and the administration to respond, should silence talk of a rapid exit from QE2 and put QE3 back on the table. The case for additional easing is strong. A responsible central bank is always mindful of the risk of inflation – but with wages showing no sign of responding to the blip in prices, this danger is hardly imminent. True, exiting from an even larger programme of easing will pose problems, but again this should be weighed against the much greater costs of a failing recovery.

The economy is faltering and the government – if not actually making things worse – is flailing uselessly. The Fed is all there is.
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Copyright The Financial Times Limited 2011.