Peter S. Goodman,
NYT) August 30, 2010 — The American economy is once again tilting toward danger.
Despite an aggressive regimen of treatments from the conventional to the exotic
— more than $800 billion in federal spending, and trillions of dollars worth of
credit from the Federal Reserve — fears of a second recession are growing, along
with worries that the country may face several more years of lean prospects.
On Friday, Ben Bernanke, chairman of the Fed, speaking in the measured tones of
a man whose word choices can cause billions of dollars to move, acknowledged
that the economy was weaker than hoped, while promising to consider new policies
to invigorate it, should conditions worsen.
Yet even as vital signs weaken — plunging home sales, a bleak job market and, on
Friday, confirmation that the quarterly rate of economic growth had slowed, to
1.6 percent — a sense has taken hold that government policy makers cannot
deliver meaningful intervention. That is because nearly any proposed curative
could risk adding to the national debt — a political nonstarter. The situation
has left American fortunes pinned to an uncertain remedy: hoping that things
somehow get better.
It increasingly seems as if the policy makers attending like physicians to the
American economy are peering into their medical kits and coming up empty, their
arsenal of pharmaceuticals largely exhausted and the few that remain deemed too
experimental or laden with risky side effects. The patient — who started in
critical care — was showing signs of improvement in the convalescent ward
earlier this year, but has since deteriorated. The doctors cannot agree on a
diagnosis, let alone administer an antidote with confidence.
This is where the Great Recession has taken the world’s largest economy, to a
Great Ambiguity over what lies ahead, and what can be done now. Economists
debate the benefits of previous policy prescriptions, but in the political realm
a rare consensus has emerged: The future is now so colored in red ink that
running up the debt seems politically risky in the months before the
Congressional elections, even in the name of creating jobs and generating
economic growth. The result is that Democrats and Republicans have foresworn
virtually any course that involves spending serious money.
The growing impression of a weakening economy combined with a dearth of policy
options has reinvigorated concerns that the United States risks sinking into the
sort of economic stagnation that captured Japan during its so-called Lost Decade
in the 1990s. Then, as now, trouble began when a speculative real estate frenzy
ended, leaving banks awash in debts they preferred not to recognize and hoping
that bad loans would turn good (or at least be forgotten). The crisis was
deepened by indecisive policy, as the ruling party fruitlessly explored ways
around a painful reckoning — boosting exports, tinkering with accounting
“There are many ways in which you can see us almost surely being in a
Japan-style malaise,” said the Nobel-laureate economist Joseph Stiglitz, who has
accused the Obama administration of underestimating the dangers weighing on the
economy. “It’s just really hard to see what will bring us out.”
Japan’s years of pain were made worse by deflation — falling prices — an
affliction that assailed the United States during the Great Depression and may
be gathering force again. While falling prices can be good news for people in
need of cars, housing and other wares, a sustained, broad drop discourages
businesses from investing and hiring. Less work and lower wages translates into
less spending power, which reinforces a predilection against hiring and
investing — a downward spiral.
Deflation is both symptom and cause of an economy whose basic functioning has
stalled. It reflects too many goods and services in the marketplace with not
enough people able to buy them.
For more than a decade, the global economy was fueled by monumental spending
power underwritten by a pair of investment booms in America — the Internet
explosion in the 1990s, then the exuberance over real estate. As housing prices
soared, homeowners borrowed against rising values, distributing their dollars to
furniture dealers in suburban malls, and furniture factories in coastal China.
But the collapse of American housing prices severed that artery of finance.
Homeowners could not borrow, and they cut spending, shrinking sales for
businesses and prompting layoffs.
Early this year, some economists declared that the cycle was finally righting
itself. Businesses were restocking inventories, yielding modest job growth in
factories. Hopes flowered that these new wages would be spent in ways that led
to the hiring of more workers — a virtuous cycle.
But the hopes failed to account for how extensively spending power had dropped
in the American economy, and how uneasy people were made by every snippet of
data showing that houses were not selling, employers were not hiring, and stock
prices were foundering.
Now, a new cause for concern is growing: the flat trajectory of prices, which
might metastasize into a full-blown case of deflation.
The primary way to attack deflation is to inject credit into the economy, giving
reluctant consumers the wherewithal to spend. The chief deflation fighter is the
Federal Reserve, which traditionally adjusts a benchmark overnight rate for
banks that influences rates on car loans, mortgages and other forms of credit.
The Fed pulled this lever long ago, and has kept its target rate near zero since
The Fed has also been more creative. During the worst of the financial crisis,
the Fed relieved American banks of troubled investments, many linked to
mortgages, to give the banks room to make new loans.
This engendered the sort of debate likely to fill doctoral dissertations for
generations. Most economists praise the Fed for confronting the possibility of
another depression. But the Fed added to the nation’s debts, provoking talk that
it was testing global faith in the dollar.
The dramatic expansion of the national debt — which began in the Bush
administration, via hefty tax cuts and two wars — has ratcheted up fears that,
one day, creditors like China and Japan might demand sharply higher interest
rates to finance American spending. Those rates would spread through the economy
and inflict the reverse of deflation: inflation, or rising prices, as merchants
lose faith in the sanctity of the dollar and demand more dollars in exchange for
oil, electronics and other items.
So far, the reverse has happened. As investors lose faith in real estate and
stocks, they are flooding into government savings bonds, keeping interest rates
exceedingly low. Still, inflation worries occupy the people who control money,
not least the governors of the Fed. The Fed has been seeking a graceful exit
from its interventions, aiming to unload its cache of mortgage-linked
investments and — likely in the far future — lift interest rates.
But the recent disturbing economic news has delayed those plans. This month, the
Fed said it would take the proceeds from its mortgage-linked investments and buy
Treasury bills to keep longer-term interest rates down. The Wall Street Journal
reported that this decision came amid substantial disagreement among the Fed’s
governors, suggesting that future action will be constrained by fears of
Republicans in Congress have embraced further tax cuts and less spending as the
answer to the weak economy, while accusing the administration of squandering
stimulus spending on efforts that brought little gain. Some conservative
analysts liken the government’s reliance on spending and credit to imbibing
another cocktail to take the edge off a hangover. In this view, the weak economy
should be welcomed for the discipline it imposes, forcing a paring back of
unsustainable spending, while building up savings that can finance investment
and later feed healthy economic growth.
“The recession is the cure for the disease that affects the economy, but the
politicians don’t have the stomach for it,” says Peter Schiff, president of Euro
Pacific Capital, a Connecticut-based brokerage house. “They’re going to keep
stimulating the economy until they kill it with an overdose. The hyper-inflation
that results is going to be far worse than the cure.”
Germany, which has long harbored particularly powerful fears of inflation, has
done relatively well in the current downturn without large stimulus spending,
and that experience is now cited by adherents of austerity. But it can be argued
that the Germans had two advantages over Americans: A more extensive social
safety net to give consumers more money and the confidence to spend it, and a
vibrant manufacturing base to churn out more goods for export.
Most economists who are close to the policy making arena for both parties take
the position that austerity is the wrong medicine for what ails the American
economy, and they dismiss warnings about inflation as akin to focusing on the
side effects of chemotherapy in the face of cancer. First, they argue, take the
medicine and stave off the lethal threat; then deal with the collateral
Regardless, inflation fears persist, constraining what limited prescriptions
might otherwise be thrown at a weakening economy.
The impending elections in November — with control of Congress hanging in the
balance — has further narrowed the contours of political possibility
Six months ago, Alan Blinder, a former vice chairman of the Federal Reserve, and
now an economist at Princeton, dismissed the idea that America’s political
system would ever allow the country to sink into a Japan-style quagmire. “Now
I’m looking at the political system turning itself into a paralyzed beast,” he
says, adding that a lost decade now looms as “a much bigger risk.” Congress and
the Obama administration have ruled out further stimulus spending. The Fed
appears to be running out of powder. “Its really powerful ammunition has been
expended,” Mr. Blinder says.
Even after the November election, few expect a different dynamic. “We’re already
in a gridlock situation, and nothing substantive is going to change,” says Bruce
Bartlett, who was a Treasury economist in the first Bush administration.
“Clearly, a weak economy in 2012 will be very good for whoever the Republican
presidential candidate is. It’s hard to see how the Republicans lose by blocking
On the other hand, if deflation emerges as a verifiable menace, many economists
expect Mr. Bernanke — an expert on the Great Depression — to again champion
aggressive measures, perhaps expanding the Fed’s balance sheet to buy pools of
auto loans or credit card debt.
“It’s very likely the Fed will bend in that direction if the economy stays soft,
especially if they are starting to see deflation,” says Kenneth S. Rogoff, a
former chief economist at the International Monetary Fund, and now a professor
at Harvard. “That’s really starting to loom.”
On Friday, Mr. Bernanke, whose board can operate independent of politics and the
government, offered assurance that he still had powerful therapies to use should
conditions worsen. Yet he also expressed concern about the potential side
effects, underscoring a reluctance for more action.
“The issue at this stage is not whether we have the tools to help support
economic activity and guard against disinflation,” he said. “We do.” Then he
added: “The issue is instead whether, at any given juncture, the benefits of
each tool, in terms of additional stimulus, outweigh the associated costs or
risks of using the tool.”
Right now, many homeowners owe the bank more than their homes are worth,
prompting some to abandon properties, adding inventory to a market choked with
vacant addresses. An Obama administration program aimed at slowing foreclosures
has prolonged trouble, say some economists, by failing to relieve borrowers of
unsustainable debt burdens or making transparent the extent of losses yet to be
confronted by the financial system.
“The big question is, who’s going to swallow the losses,” says Mr. Stiglitz. “It
should be the banks, but they don’t want to. We’re likely to be in paralysis for
years if they prevail.”
The Treasury sits in the middle, concerned by the continued weakness of housing,
yet unwilling to pressure banks to write down mortgage balances.
Like their Japanese counterparts a decade ago, Treasury officials worry that
forcing the banks to take losses could weaken them and risk another crisis.
By default, muddling through has emerged as the prescription of the moment.