Friday, February 1, 2008

Economic stimuli?

Ben Bernanke is among the world's foremost experts on central banking, so presumably his grasp of the economy is superior to mine. On the other hand, I'm under no pressure from either Washington or Wall Street. I just call it the way I see it, and you can decide for yourself which of us is more credible.

Did it really make sense to drop interest rates twice in nine days, all the way down to 3%, and hint that further cuts may lie ahead? I just can't see it. Granted, it seems to have encouraged Wall Street as stock prices have edged upward for the past four days, but if you're not an executive whose bonus depends on your company's stock price or a retiree planning to cash out your 401K next week, that's meaningless. Credit remains very nearly as tight as it was before the rate cuts. As long as banks and other businesses continue to write down multi-billion dollar losses, loans will be hard to find.

The main thing the rate cuts are likely to do is further depress the value of the dollar, making it harder for both government and corporate America to borrow from overseas. If our creditors lose any more confidence in the dollar and insist on denominating our future loans in euros, for example, we'll be in a hell of a lot more trouble.

Just what I need! A tax rebate!
Ideologically constipated as always, the administration can't think past tax cuts -- and since giving away money is a proven vote getter, Congress is right on board. The idea, as you know, is to stimulate the economy by giving people more money to spend. But how will they spend it?

The poor, certainly, will spend what they get in short order. Items like food and rent usually are a safe bet, especially given the job losses reported for January. There will be some multiplier effect, as grocers and landlords re-spend some of the money they receive. So far, so good. If Senate proposals to extend unemployment insurance and food stamps become part of the final package, so much the better. The poor can be counted on to spend whatever they get.

The middle class is a different story. Faced with recession (and the concomitant threat of job losses, less overtime, and giveback demands from their employers), the middle class tendency is to circle the wagons. Many will use their rebates to pay down existing debt. A few will try to save their rebate money as a hedge against unexpected problems. In those cases, the multiplier effect will be zero.

Many will pump their rebate checks directly into the tanks of their SUVs, or use them to offset increases in the price of corn. That will help maintain demand for oil and ethanol, keeping fuel and food prices high.

I continue to be concerned about the threat of inflation, even though the current wisdom tells us that inflation is entirely a thing of the past. It may be true that labor is too debilitated to contribute to a wage-price spiral, but there are new possibilities arising out of globalization. Buying power in the developing world is growing faster than the global supply of goods, so demand-pull inflation is inevitable -- and the Fed can't control that at all. The impact of demand on fuel prices will generate cost-pull inflation as well.

A few weeks ago, I cautioned against the threat of stagflation, and nothing has happened since then to change my outlook. While the economy continues to tank, inflationary pressures continue to grow. Today's New York Times reports that labor shortages and an increase in the cost of raw materials in China -- combined with the weakness of the dollar -- are likely to increase the price of Chinese-made goods in the United States by as much as 10% this year. (I'm betting on more than that, especially if the Fed continues to cut interest rates.)

Buy anything made in China lately?

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