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Sept 24, 2010
by Don Azarias
A couple of months ago, a friend of mine from the cyberspace who loves to invest in the stock market made a friendly bet with me that the Dow Jones Industrial Average (DJIA) would be up to 11000 or 12000 by this time. Basing my calculations on the results of leading economic indicators, I decided to be cautious and told him that the DJIA would stay between 9500 and a little over 10000 during the same period. And to be honest with you, I was hoping that he was right. However, at the rate the economy is faring, I’m beginning to think that our bet will end up in a draw. The DJIA is currently between 10000 and 11000. Whatever the outcome, it’s something worth rejoicing because it’s not really as bad as most economists and analysts have predicted.
Let’s all be realistic and face the sad truth: There is really no easy way to fix the slumping economic recovery. Even the brightest minds and those so-called economic savants are baffled by the resilience of this Great Recession that has been wreaking havoc nationally and globally. The lingering effect of this stubborn recession is causing world leaders, including U.S. President Barack Obama and his fellow Democrats, a lot of grief.
The sluggish economic recovery is further exacerbated by unwelcome news that Americans spent less at most retail stores in July. Earlier this month came word that the trade deficit is ballooning and companies are not adding jobs fast enough to bring down unemployment.
Typically, the Fed can lower interest rates to encourage Americans to borrow money and spend it in order to stimulate the economy. But the benchmark interest rate controlled by the Fed has been almost zero for more than a year now. The Fed this week took a new step by announcing it would use the proceeds from its huge portfolio of mortgage securities to buy government debt. The idea is to make cheap credit a little cheaper, particularly for things like mortgages.
However, the biggest obstacle is that American workers are worried about their jobs that borrowing is the least of their priority. They would rather save than spend in order to build up “rainy day funds” because of economic uncertainties. And since the volatility in the stock market is in full swing, who can blame them for not spending? Alice Rivlin, who was the second highest ranking official of the Federal Reserve in the late 1990s had this to say: “You can’t force people to take out a loan or spend money that they don’t want to spend.” And who can disagree with her?
While the Fed’s power is not limitless, is still has other options available. It could launch another trillion-plus-dollar program to buy government debt or mortgage securities like it did when it was battling the Great Recession and financial crisis. Or the Fed could cut to zero the rate it pays banks to stockpile cash inside their vault to extend more loans to consumers. However, in today’s economic climate, banks are more cautious when it comes to lending and you can’t blame them.
Congress has the power to regulate the economy by adjusting tax rates and passing stimulus programs. But there is little interest on Capitol Hill to undertake a major new stimulus effort. The midterm elections are just a few weeks away and, Republicans and Democrats alike, are in no mood to do it again, fearing voters backlash due to the federal government’s $1.4 trillion deficit.
However, Fed chief Ben Bernanke, a scholar of the Great Depression has warned Washington policymakers not to repeat mistakes made during the Great Depression by pulling in government stimulus too quickly. Bernanke also suggested recently that extending the Bush tax cuts, at least for a while, would be one way to “maintain a reasonable degree of fiscal support——stimulus——for the economy.”
But Democrats and Republicans are divided on what to do. Most Republicans want to make permanent the tax cuts enacted under President George W. Bush in 2001 and 2003. That would amount to nearly $3 trillion over the next decade. Democratic leaders want the cuts for the wealthiest Americans to expire.
That leaves the work of jump-starting the economy for the time being to everyday Americans and businesses, who can spend money and accelerate the cycle of growth. But both are in a frugal mood. Mortgage rates have sunk to record lows: Rates on 15-year mortgages dropped to 3.92 percent and 30-year mortgages to 4.44 percent. Still, people aren’t scrambling to buy homes or refinance the ones they already have.
Businesses, meanwhile, are sitting on a record $1.84 trillion pile of cash, according to the Fed. They aren’t using the money to expand operations or hire new workers because they, too, have doubts about the strength of the economic recovery. The economy grew at a 2.4 percent pace in the second quarter, about half as fast as it was growing late last year. And it may turn out, as the manufacturing sector is hurt by declining exports, that growth right now is even slower than we think.
And the stock market, which had managed a significant rally in July, is now absorbing the blow of the economic pessimism. The Dow Jones industrial average recently fell from about 10,700 to about 10,300.
A rebound in housing is considered critical for a sustained economic recovery. But builders continue to struggle with weak demand for new homes caused by high unemployment and a glut of foreclosed homes on the market. The July increase in housing construction pushed total activity to a seasonally adjusted annual rate of 546,000 units. Building activity in June was weaker than first reported. It fell 8.7 percent to an annual rate of 537,000 units, the slowest pace since October of last year.
Housing construction got a boost earlier in the year when the government offered buyers up to $8,000 in federal tax credits. But after the incentives expired at the end of April, sales and constructions activity slumped.
Builders say consumers remain worried about the weak economic recovery and the large number of unemployed workers. Since this is a buyer’s market, many of those buying are opting for deeply discounted foreclosed properties. I, personally, believe that this is a bad sign for the long anticipated economic recovery.
There’s really no end in sight for this recession as various adverse economic factors continue to bedevil the U.S. economy. But most economists believe that the economy is now improving.
Oh, really?
Don Azarias