Beyond A Recession

Source : The Straits Times, May 03, 2008

GOVERNMENT and business leaders in Asia are in a tizzy over the behaviour of the American economy.

They can manage a brief recession there, but stagflation will be trouble. A lengthy period of stagnant growth, inflation and job losses coming three decades after the last one could spin the globe out of kilter. Asia endured reasonably well Japan's decade-long stagnation starting in the early 1990s because prices were stable. During that period, America was prospering under President Bill Clinton's budget surpluses. A combination this time of two factors - financial corrosion and a credit drought in America hurting businesses, plus a worldwide food and non-food commodities spiral stoking inflation - is causing concern about how United States policymakers will fight two fires in one go.

Oil prices that keep climbing are busting growth projections all over, just as the oil embargo and price spike of the 1970s introduced the world to the stagflation phenomenon. Asian leaders were watching the US Federal Reserve Board's rates move this week for leads on which its governor Ben Bernanke saw as the greater danger. They were liable to have been as confused as American economists and business leaders said they were, not by a further cut in the federal funds rate by a quarter-point to 2 per cent, but by his fudging about what the Fed regarded as the greater immediate threat to the economy. One wished the Fed's regional governors had powers of divination.

The US economy grew 0.6 per cent in the first quarter annualised. In the view of analysts, only inventory stocking stopped a contraction. But rising inventories coupled with weak sales often indicate economic distress ahead. The Fed signalled it was focused on bolstering growth confidence as consumers cut spending in tandem with declines in property value, business investment and employment.

The Fed's growth bias is comprehensible, but the matter of the correct policy balance is confounding. Opinion in America tends towards the Fed making another cut later in the year. What would the ripple effect around the world be if US growth remained sluggish after that, with interest rates having been brought to the floor on top of a loans handout to Wall Street firms?

Many Asian governments have signalled they have factored in a short US recession in their contingency planning while battling to regain price stability. The worry is whether the Fed is under-weighting the inflation risk in growth recovery cycles. Energy and food prices have not peaked, many experts counsel. By the time the Fed turns its full attention to fighting inflation with rate hikes when business activity is flat, a perfect storm could be brewing.

Yang Huiwen