The Economy Starts to Slow?

The fact that the number of new jobs created last month was a paltry 75,000 is a good indicator that the economy may be on the brink of a slowdown. The New York Times has a report here: Jobs Report Signals Cooling Economy. This job figure is pretty pathetic and reinforces, yet again, the view that the last few years have been rotten for the average American worker. Bush’s economic policies have failed totally to generate a strong employment market, despite the huge cost of the supposed stimulus applied by those notorious tax cuts. This simple data point is yet another indictment of effectiveness of Bush’s management of the economy.

Of course at the aggregate level growth has been strong for a while [even though the average American may not realise it!], so strong that the Federal Reserve Board has been forced to focus on inflation as a serious threat for the first time in over a decade. Not only are the traditional sources of inflation showing signs of life: even wages are rising a little for the first time in the Bush administration, but rising oil prices and a sinking dollar are adding to the inflationary upturn. As the dollar sinks import prices tend to go up, and so much of what we buy is now imported that import prices are a larger source of inflation than in the past.

So this is the worst time to be a Fed chairman or incoming Treasury Secretary. Rising inflation implies that the Fed would like to increase interest rates to cool the economy. But a whole bunch of signs, like the poor job creation figures for May, indicate that the economy is already slowing down. So why doesn’t the Fed just sit back and let things take care of themselves? Because the world markets for credit are increasingly nervous about those pesky “imbalances” in the US trade and budget accounts. In order to attract capital to pay for its continued splurging the US may have to keep rates going higher even though its economy is already cooling off. In other words monetary policy will have to be tighter than necessary because fiscal policy is rampantly, or should I say wantonly, out of control.

And the Treasury Department, whose job it is to oversee those accounts, will want to allow the dollar to fall so as to make American goods more competitive and thus help to close the trade deficit. The problem, as I just indicated, is that this would fuel inflation. Further: the massive and out of control budget deficit will be driving up long term rates. This will dampen an already cooling housing market even more. All the evidence now points to a much weaker housing market for the next few months anyway so rising rates could tip us into a much sharper decline. Our new Treasury Secrtary will want to react to market pressures by cutting the deficit [good luck in an election year!], but by so doing he would be taking money out of an already weakening economy, thus amplifying the slowdown.

So: the Fed wants rates to rise a little to dampen inflation, but not enough to cause a recession. Treasury wants the dollar to fall which will cause a rise in inflation, and it wants to reduce the budget deficit which will slow the economy and would have reduced inflation were it not for the falling dollar.

I hope you got all that.

This is an example of the kind of mess you can create when you run ridiculously foolish economic policies the way the US has for the last few years.

The upshot: the economy will slow down this year. If we are lucky we won’t experience a recession. But the risks of that happening are rising daily, and to an increasing degree the key decisions are now being taken abroad.

It’s called losing control. Let’s hope the Fed and Treasury can cooperate and make up for the lack of any substance elsewhere in Washington.