From The Sunday Times
March 22, 2009
Soon there may be nobody left to lend to America
Irwin Stelzer
Anyone
who thought Ben Bernanke and his Federal Reserve Board
colleagues were out of ammunition received a rude, or pleasant,
shock
last week. Rude, if you worry that a few extra trillions sloshing
around the economy might one day trigger a wave
of inflation;
pleasant, if you worry that the economy is sinking fast, and the Obama
administration and Congress haven’t
a clue what to do about it.
The Fed plans to buy $300 billion of Treasury IOUs in the next six
months (more to come
if needed), pour $1.45 trillion into the mortgage
market, and keep interest rates close to zero for “an extended
period”.
There’s more in the Fed’s “do whatever it takes” arsenal if
these steps don’t bring interest
rates down so people can borrow more
cheaply to buy houses, cars and other durable goods. But so far, so
good: interest
rates on 30-year mortgages fell below 5%. Whether that
will encourage enough creditworthy borrowers to sop up the huge
inventory
of unsold homes, much less trigger new construction, is
difficult to predict.
But the dollar dropped like a stone.
Earlier, Chinese premier Wen
Jiabao said he was “a little bit worried” that America might cheapen
its currency
and pay back the $1.2 trillion it owes in depreciated
dollars. Now that the Fed has moved, he must be a lot worried.
The
Fed’s decision to pump trillions into the money markets comes on
top of President Barack Obama’s proposal to
drive the federal deficit
to 12% of GDP by borrowing trillions to fund a few stimulus projects,
universal healthcare,
a green energy system and a host of other
programmes on his wish list. Obama’s assurance that America will never
default
on its debt hasn’t completely soothed the markets: The Wall
Street Journal reports that it now costs seven times
as much to buy
insurance against an American government default as it did only a year
ago. Besides, America can always
inflate its way out of its
obligations.
Not to worry, says the president. The economy will soon be growing at
an
annual rate of about 4%. Along with the tax increases to be imposed
on the top 2% of earners, billions from the sale of
carbon-pollution
permits and reductions in age-related entitlements, the growth will
drive the deficit down to 3% of
GDP in 2013. Unfortunately, 2% of
earners can’t or won’t carry the entire burden, the carbon-permit
programme
might not produce the predicted revenues after Democratic
congressmen from coal-producing states chop away at it, and Congress
has
told the president that any proposal to reduce the huge
entitlement payments due the ageing baby-boomers will be DOA –
dead on
arrival.
Where China’s Wen sees problems, Paul Paulson (no relation to former
Treasury secretary
Hank) sees opportunity. Paulson, you will recall,
is the hedge-fund manager who made $10 billion in 2007 betting that
the
subprime mortgage market would implode. The day before Bernanke’s
announcement, Paulson made another wager. He shelled
out $1.28 billion
for a stake in the gold-mining company AngloGold Ashanti. He is
betting that by debasing their currencies,
governments will trigger
inflation that will cause a flight from paper currencies to gold.
Within 24 hours of Paulson’s
bet, it paid off, thanks to the Fed: the
price of gold jumped 7%, one of the many commodities to experience
large increases.
So
here is where we are at. The combination of the Fed’s surprise
attack on the credit markets and the president’s
decision to
borrow-and-spend will give the economy a lift. My own guess, and that
of many economists with whom I have
spoken, is that by the middle of
next year, if not sooner, the economy will start growing again at a
decent rate.
At
that point, Bernanke will have to decide whether to start pulling
money out of the system by selling off some of the assets
on his
swollen balance sheet, and the Obama administration will have to
decide how to bring down the fiscal deficit.
Bernanke is keenly aware
that during the Great Depression the Fed tightened the money supply
prematurely, nipping a
nascent recovery in the bud. So he is likely to
stall.
Meanwhile, there is little prospect that Congress will do
what is
necessary to bring spending and borrowing down to levels that do not
trigger inflation. Politicians just don’t
worry as much about
inflation as about catering to their multiple constituencies. So the
Treasury will have more trillions
in IOUs to peddle.
But its best customers just might be unenthusiastic about adding
significantly to their holdings.
Wen already owns trillions in
Treasury bills that are depreciating in value. Besides, China’s
mounting needs for
infrastructure and an improved safety net will sop
up funds once used to buy American securities. Japan, another large
customer,
is now running a current-account deficit, and so it won’t
have as many dollars to recycle. Nor will Middle East buyers,
no
longer receiving a flood of dollars from $140-a-barrel oil. Little
wonder that Larry Lindsey, former economic adviser
to President George
W Bush, says he “cannot figure out what combination of foreign buyers
is going to acquire
. . . [the] debt” that Obama’s plans will
generate.
Which leaves Americans and the Fed as customers.
Even if they save
more, domestic consumers can’t absorb all the Treasury bonds that will
be on offer. And if the
Fed keeps buying, it will pour fuel on the
inflationary fires.
I have never before doubted the resilience of the
American economy –
its ability to survive inevitable downturns after periods of excess,
and to weather the burdens
heaped on it by politicians. Obama,
however, has me shaken, perhaps because I am not stirred by his
rhetoric.
Fortunately,
even some liberal Democrats are suffering from “bailout
fatigue”. More important, Bernanke has so far shown
a sure touch in
managing monetary policy, and might head off a bout of inflation by
shrinking the money supply when
the economy is no longer too cold, has
not yet gotten too hot, and is in just the right condition for such a
move. If
so, Goldilocks might just have a new life.
Irwin Stelzer is a business adviser and director of economic policy
studies
at the Hudson Institute.
stelzer@aol.com
