“Unusually uncertain”. That’s how Ben Bernanke described the outlook for the US economy in his recent testimony to Congress. It is also how John Chambers, the CEO of Cisco Systems described the outlook on the conference call for his company’s latest earnings report. Neither man has a very good track record at predicting the future course of the economy - no one does - so when they say the outlook is unusually uncertain it means….what exactly? Based on their track records one could easily conclude that a pronouncement of unusual uncertainty is finally an admission of fallibility from two lousy forecasters, but they aren’t the only ones making the argument that uncertainty is impeding the economic recovery. In a recent speech Richard Fisher of the Dallas Federal Reserve ascribed the lack of economic activity to what he called “random refereeing”:
For some time now in internal discussions with my colleagues at the Fed, I have ascribed the economy's slow growth pathology to what I call "random refereeing""”the current predilection of government to rewrite the rules in the middle of the game of recovery. Businesses and consumers are being confronted with so many potential changes in the taxes and regulations that govern their behavior that they are uncertain about how to proceed downfield. Awaiting clearer signals from the referees that are the nation's fiscal authorities and regulators, they have gone into a defensive crouch.
There are indeed a lot of changes in the pipeline for individuals and companies. What will happen with tax rates next year? Will capital gains taxes go up? How much? Will dividend tax rates be raised all the way back to the regular income tax rate? What will the President’s deficit commission recommend? A VAT despite Barney Frank’s protestations to the contrary? Will government spending be reduced to close the deficit or will the politicians raise tax rates to try and close the gap? What about accelerated depreciation? If a company makes an investment today will they get to expense it right away or will it have to be depreciated over time? Will health care reform be implemented as written? For that matter do we even know what the rules will be yet? Will the states AGs be successful in challenging the bill on Constitutional grounds? Will it be repealed or changed significantly?
What about financial regulatory reform? How long will it take for regulators to write the rules based on the guidelines laid out by Congress? What about the stimulus? Will the infrastructure spending ever start in earnest? Will the tax provisions be extended again? What about unemployment benefits? Will Congress continue to extend them indefinitely? Will there be another stimulus package? If so, will it be tax cuts, direct spending or more grants to the states? Will California, Illinois or the other insolvent states be forced to finally address their structural deficits? What will happen with Fannie Mae and Freddie Mac? Will the administration and Congress enact another foreclosure mitigation program? Will Fannie and Freddie be forced to reduce principal on mortgages? Will Lebron James, Dwayne Wade and Chris Bosh be able to share the basketball? Sorry that last one is only a source of anxiety here in Miami….
There is no doubt that the Obama administration’s agenda has increased the uncertainty surrounding the economic situation. When Christina Romer resigned a couple of weeks ago an article appeared in The Hill that implied one of the reasons for her departure is that the President’s economic team is tired:
President Obama's economic team is exhausted, according to White House spokesman Robert Gibbs, and that is one of the reasons Christina Romer announced her departure Thursday.
Gibbs dismissed reports that Romer, the outgoing chairwoman of the president’s council for economic affairs, was leaving because of conflicts with Larry Summers, the director of the National Economic Council.
The press secretary told The Hill on Friday that Romer and the rest of the economic team have worked the equivalent of six years during the 18 months they've been in office, and Romer wanted to return to her normal life.
“These guys have probably packed a term and a half into a half of a term,” Gibbs said.Romer is the second member of the economic team to leave this summer. She follows Peter Orszag, director of the Office of Management and Budget.
The early days of the administration alone were enough to wear the team down, he said, as they realized the depth of the recession.
“If you think about what we went through in the beginning, nobody knew when we woke up if the whole thing was just going to come crashing down,” Gibbs said.
Romer was involved in the administration's planning of the $787 billion economic stimulus package. Ever since the legislation was approved by Congress, she's been at the forefront of the administration's effort to sell the product to the public.
Well, surely if the President’s economic team is tired from imposing their agenda the pubic is exhausted from trying to interpret and deal with the consequences of it. Americans are exhausted from looking for jobs that don’t exist. They are tired of waiting for the mythical benefits of the stimulus plan. They are exhausted from the debates about health care and financial regulation. They are drained from worrying about the lives of our soldiers fighting a war in Afghanistan that appears to the average person to be a complete waste of time, money and lives. They are worried to death about the consequences of large deficits and the bill for the coming wave of baby boomer retirements. And while Mrs. Romer can go back to her tenured position at Berkley, businesses will be dealing with an onslaught of new rules, regulations and taxes.
But…..I have a problem with believing the uncertainty of the administration’s legislative agenda is the main reason the economic recovery has stalled. Every new administration has an agenda and campaign promises that they must at least attempt to fulfill. George W. Bush had different priorities than Bill Clinton who had different ideas than George H. W. Bush who once described Ronald Reagan’s economic plan as voodoo. Yes, the agenda of the Obama administration is more ambitious than anything we’ve seen in the US in quite a while - and I don’t agree with much of it - but American multinationals do business in a variety of political environments around the world. Is the Obama administration more activist than the other left of center governments of the world? Or the real leftist versions in some countries? I find it hard to believe that companies who are perfectly capable of doing business in Europe are unable to navigate the current US political environment.
But since Bernanke brought it up, what about the uncertainty provided by the Fed itself? Despite what you may have heard from the various sources of economic misinformation in the media, monetary policy is not that complicated, consisting of nothing more than balancing the supply of and demand for dollars. Ideally the Fed would be able to get that balance right, stabilize the value of the dollar and therefore prices. The problem is that there are lots of ways to measure the value of the dollar and getting it wrong - as we’ve seen - has major consequences. The modern way to measure the success or failure of monetary policy is to target a price index for a basket of goods called the Consumer Price Index. Unfortunately for the Fed, the US and the world that method hasn’t worked very well over the last 40 years. Does this look stable?
How about this?
Or this?
That’s three alternate means of measuring the value of the dollar and all of them show exactly the same thing. It isn’t stability. Since 1995 the US dollar index first rose by 50%, fell by 40%, rose by 24%, fell by 16%, rose by 20% and finally fell 10%. Furthermore, the swings have become more frequent recently. The initial 50% rise took 7 years (1995 to 2002; roughly the internet bubble) with never more than a 8% correction. The 40% fall took six years (2002-2008; roughly the housing and commodity bubble) with the biggest countertrend move being 15%. Then during the recent crisis and the aftermath, Fed policy allowed the dollar to rise 24% in 8 months, fall 16% in 9 months, rise 20% in 8 months and finally fall 10% in just 3 months.
This dollar volatility is transmitted to a variety of markets that affect business. Rapidly fluctuating commodity prices, interest rates and exchange rates transforms the job of business planning from a difficult one to a nearly impossible one. It raises costs as businesses must devote capital to hedging those risks over which they have little control or ability to evaluate. It affects investment decisions around the world as companies must not only anticipate changes in Fed policy but also how those changes will affect their costs in different countries and currencies. Companies must worry that the Federal Reserve will fail to prevent deflation while simultaneously fearing that they will succeed too well and instead set off an inflationary spiral. With vastly different approaches required for survival depending on the outcome, businesses choose to minimize risks while awaiting the Fed’s next move.
The Fed’s attempt to control inflation by targeting the consumer price index has failed miserably. It has failed because the composition of the index is both arbitrary and subject to political manipulation. Measuring the value of money is a difficult task and reasonable people disagree about how best to accomplish it but when all measures agree that the value has been volatile except for the one in official use, should one question the market based measures or the one that is constructed by the government and gives anomalous readings? Is gold wrong or the CPI? Is the CRB index wrong or the CPI? Is the trade weighted US dollar index wrong or the CPI? Is the oil market wrong or the CPI?
The outlook for the economy is indeed unusually uncertain right now but Ben Bernanke and the Fed are the primary source of the anxiety, not Congress. The Federal Reserve is the only institution in Washington that has the ability - indeed the mandate - to provide a stable economic environment. They have failed miserably at both their mandates - stable prices and maximum employment - because they have failed at controlling the one variable over which they have control - the value of the dollar. Businesses will never have a stable legislative environment in which to operate but they should be able to depend on a stable monetary environment. Until they can, the uncertainty and the sluggish recovery will continue.
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