When Economic Reality Starts to Bite

Irwin M. Stelzer, a contributing editor to The Weekly Standard, is director of -economic policy studies at the Hudson Institute and a columnist for the Sunday Times (London).

A new paper by Carmen Reinhart and Kenneth Rogoff, professors of economics at the University of Maryland and Harvard University respectively, covers the experience of 44 countries over 200 years and concludes, "Our main finding is that across both advanced countries and emerging markets, high debt/GDP levels (90 percent and above) are associated with notably lower growth outcomes…. Seldom do countries simply 'grow' their way out of deep debt burdens." If you are the worrying sort, add to these your answer to a question put by Larry Summers, now the president's economic adviser but at the time free to speak his mind, "How long can the world's biggest borrower remain the world's biggest power?" Efforts to reach Mr. Summers to obtain his current answer to his question proved unavailing.

Reality bared its teeth in several ways. Friday's jobs report did not show the hoped-for increase in hiring, but a further loss of 20,000 non-farm jobs. That is a far lower rate of job loss than the 700,000 recorded in the early months of the Obama administration, and the unemployment rate did drop to 9.7 percent. But that decline was due largely to 366,000 more workers becoming so discouraged that they dropped out of the work force. The ugly reality is that the estimate of the number of jobs lost since Obama moved into the White House has been revised upward from 7.2 million to 8.4 million; the number of long-term unemployed (27 weeks and more) has increased by five million; and that even by its own projections unemployment will remain high for the rest of the president's first and, if he has one, second terms. Some of this the president inherited, but voters are increasingly of the view that the Obama administration, despite or perhaps because of its wild spending, cannot create an atmosphere that will encourage employers to start hiring again.

Then came another brush with reality. Moody's Investors Service warned that the triple-A rating accorded America's sovereign debt will "at some point" come under pressure unless "measures are taken to reduce the budget deficit further or the economy rebounds more vigorously than expected." Neither seems likely. The administration's own projections call for deficits that are generally regarded as unsustainable for the next ten years, rising again in 2019, long after President Obama has placed his Nobel Peace Prize on the mantel of his Chicago home. Our only hope is that the late Herb Stein, a member of the Council of Economic Advisers under Presidents Nixon and Ford, was right when he said, "If something cannot go on forever, it will stop."
The next bite from reality came from the Federal Reserve Board. It plans to end its $1.25 trillion mortgage-buying program next month. With that much money being pulled out of the mortgage market, pessimists expect interest rates to jump and the modest recovery underway in the housing market to come to a screeching halt. Fairness demands that we also note that others disagree, and say that yield-hungry investors will snap up mortgage-backed securities if interests rates spike.

The fourth bite reality took out of the administration's recovery plan came from Europe. The rate of growth predicted for Euroland, beset as it is by concerns about mounting sovereign debt, is insufficient to suck in significantly more imports. But Obama has promised to double U.S. exports in the next five years, "an increase that will support 2 million jobs" reckons the president. How he will do that without getting congress to ignore its trade union masters and approve the trade agreements gathering dust in its inbox, and without persuading the Chinese regime to allow its currency to increase in value and abandon new restrictions on imports, is nowhere explained.

Finally, reality has made nonsense of the administration's plans to stimulate the economy by making credit more available to the small- and medium-sized businesses that create most of the jobs. The problem seems to be less the unavailability of supply than the lack of demand. Banks say they are beating the bushes to find small- and medium-sized companies that want to borrow, but can find few takers. Continued uncertainty as to the future course of government policy on taxes, health care, energy costs, and other matters make entrepreneurs reluctant to borrow. "If we expect large changes but are very uncertain as to what precise form these changes will take, then our confidence will be weak," wrote John Maynard Keynes in 1936. As true today as it was then.

It might seem strange that with all of these negatives the near-term outlook is relatively good. But it is. The service and manufacturing sectors are expanding moderately. Inventory draw-downs have stopped, and businesses plan to increase stocks by 2.5 percent and capital spending plans by 9 percent, according to Financial Executives International.

Sales of existing homes in 2009 were 5 percent higher than in 2008, the first annual increase since 2005. It did take price cuts to get these houses sold, but sold they were. Prospects for the sale of new homes are sufficiently good that builders are emerging from their bunkers to bid for undeveloped land in anticipation of a increased demand for modestly priced homes.

And along comes news from the usually gloomy National Retail Federation that its members are likely to enjoy a 2.5 percent increase in retail sales this year.

All of which has politicians confused. Republicans would like to attack the administration for failing to get the economy moving, but fear that the current recovery might gain steam and make them look foolish when the November elections roll around. After all, the economy seems to be growing at an annual rate in excess of a robust 5 percent, and that hot pace is expected to continue through most or all of this year.

But some analysts liken this performance to a "sugar high," fun while it lasts. The government is injecting huge sums into the economy, and the Fed is printing money at a rate that is a tribute to the capacity and speed of the Treasury's presses. If the markets say "enough," and the Chinese stop lending us money, we will come down from the high. It will be hangover time.

By Irwin M. Stelzer:
Reprinted with permission from The Weekly Standard