Economic Sentiment In The US Getting Gloomier

Source : The Business Times, July 17, 2008

Bernanke says growth could be slower, inflationary pressures could continue mounting

US FEDERAL Reserve chairman Ben Bernanke was a bearer of bad economic news during his testimony before the Senate Banking Committee on Tuesday, suggesting that the problems facing the American economy were actually more severe than they have been for several years.

Credibility on the line: The argument made by critics in Washington these days is that the public is not going to tolerate the current conditions that allow big financial institutions to make profits in good times while making it necessary that their losses be 'socialised' through government assistance during bad times

Economic growth would probably be slower than expected while inflationary pressures could continue mounting. And the notion that inflation is up while growth is down isn't going to improve the mood of officials and lawmakers in Washington.

American consumers and investors may have already concluded that the Fed, believing inflation could get higher than expected in the coming months, is not going to lower interest rates anytime soon.

'Over the remainder of this year, output is likely to expand at a pace appreciably below its trend rate, primarily because of continued weakness in housing markets, elevated energy prices and weak credit conditions,' Mr Bernanke said during the semi-annual testimony on the US economy.

While the Fed chief predicted that the economy would improve 'gradually' in the next two years as a result of a slow recovery in the housing market, and some improvement in credit conditions - in practical terms, that means that housing may level out around the end of 2008 and that overall inflation will slow in 2009-2010.

But he also stressed the 'considerable uncertainty' regarding these more optimistic forecasts. And America's central banker emphasised that 'many financial markets and institutions remain under considerable stress, in part because the outlook for the economy, and thus for credit quality, remains uncertain'.

With the stock market dipping, inflation rising, oil prices soaring, the US dollar falling, and the continuing mess in the housing market coupled with the tightening financial crunch, there is clearly a growing sense of concern among Americans about their economic future.

As it is, at least 81 per cent of Americans have negative views about the economy, according to a recent Gallup poll. Other opinion polls show that more than half of the voters consider the economy to be the most important issue in the presidential election campaign. Against the backdrop of the collapse of IndyMac Bancorp, the large lender that was seized by federal regulators on Friday and the huge federal rescue plan of Fannie Mae and Freddie Mac, Mr Bernanke's depressing testimony was bound to raise the anxiety of Americans over the condition of the economy and highlight the problems that would be facing either Democratic president Barack Obama or Republican president John McCain next year.

And it is unlikely that the comments made by President George W Bush on Tuesday that 'there's a lot of positive things for our economy' are going to help change the depressing mood around the country.

While it would be an exaggeration to call some of the measures proposed to deal with the current economic crisis as 'creeping socialism', these plans provide government assistance to the two federally chartered agencies that are the biggest players in the residential mortgage market; consider legislation that will strengthen public oversight of financial institutions; discuss new ways that the government could stimulate the economy; and reflect a growing willingness among both Democrats and Republicans to encourage the government to play a more activist role in the process. In fact, some mainstream pundits have proposed in recent days that the government nationalise Fannie Mae and Freddie Mac. Many Democrats are pushing for legislation against 'speculation' in the energy market, which could lead to government curbs on the futures market.

And if more banks and financial institutions collapse in the coming months, triggering demands for more federal assistance, including bailouts, Congress is expected to demand that the government have more supervision and even control over the operation of these private companies.

The argument made by critics in Washington these days is that the public is not going to tolerate the current conditions that allow big financial institutions to make profits in good times while making it necessary that their losses be 'socialised' through government assistance during bad times.

This 'statist' economic mood in Washington explains why some investors in Washington are worried that Mr Obama, together with a Congress controlled by a larger Democratic majority, could take steps to impose new regulations on the financial industry.

While that could happen under worsening economic conditions, most political analysts, pointing to the close ties between the top financial houses on Wall Street and the Democratic leaders, believe that Mr Obama would continue pursuing policies friendly to the business community.

In any case, one of Mr Obama's main tasks during the last months of the election campaign would be to convince American voters that there is a connection between the war in Iraq, and in particular the gigantic increase in defence spending, and the worsening economic conditions. It remains to be seen if he will succeed.

The growing economic anxiety does pose a major challenge to Mr McCain and other Republican leaders who seem to be committed to the policies of the current Bush administration that is seen by most Americans as responsible for the current economic problems.

The combination of more job losses and rising inflation coupled with falling consumer confidence could prove to be politically deadly for any Republican running for office this year.

It is worth noting that it was the same kind of economic environment that prevailed in the US in the late 1970s, and it helped bring to power Republican presidential Ronald Reagan.