Thursday, July 17, 2008

Economic Fairy Tales

Even though it would be wonderful, there is no one with a magic wand that can wave it and make all of our current financial problems go away. Instead of turning our pumpkin into a carriage, the carriage is turning into a lemon. Our ball-gowns are now rags. Many people view really want our fairy godmother - or in our economic case - our fairy godfather to fix things and make them the way we want them to be. Unfortunately no one has that power. We spent too long in our fairy tale and now we are paying the price. This article form the Economist, titled Boxed-in Ben, illustrates how there is little that the Fed chairman can do to resolve things.

JITTERY investors and anxious politicians have often relied on Federal Reserve chairmen to conjure up something to steady their nerves. But when Ben Bernanke gave his twice-yearly monetary testimony to Congress this week he had little to offer but unvarnished and uncomfortable truths. There were “significant downside risks” to the economy’s outlook, he said, and the chances that high inflation would persist had “intensified”. Mr Bernanke did not specify which was the bigger threat: recession or inflation. This lack of a clear policy bias invited the conclusion that, for the time being at least, the Fed thinks it cannot safely move interest rates in either direction.

The Fed’s trouble is that, although the economy has avoided recession so far, it may not do so for much longer. Indeed Mr Bernanke acknowledged that some of the demand that the Fed had hoped for later this year may have already come and gone. So the economy’s first-half resilience may be of more concern than comfort.

Consumer spending seems likely to flag too. A jump in retail sales in April and May owed something to the tax rebates first sent out at the end of April. But a slim rise in retail sales in June is a hint that the effects of this one-off stimulus may already be fading. Another crutch for consumers has been the home-equity loan. Borrowing from this source rose by 3.8% between March and June, despite a big fall in overall bank credit. This increase came about partly because access is blocked to other forms of borrowing, such as mortgage refinancing. It may also be a sign of distress borrowing, as consumers battle with rising living costs. That battle will become harder if, as anecdotal evidence suggests, banks are cutting pre-arranged credit lines.

The good news in the first half may even make the Fed’s job harder. If consumers have already used up much of their tax rebates and credit lines, spending is likely to flag soon. A first-half recession followed by a sluggish recovery—the standard forecast until recently—could well have enabled the Fed to raise rates in the autumn. But with the worst news on the economy yet to come, Mr Bernanke can only keep his fingers crossed that inflation does not become ingrained.

Unfortunately sometimes there is little that can be done other than just letting things work themselves out. Well, there may be a run on pixie dust - but that really won't change much. The last round of pixie dust was called a stimulus check - and instead of resolving problems it just delayed them. Hopefully the methods they are adopting and implementing do not exacerbate the current problems.

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