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A double dip or off the cliff?

By Peter Morici
web posted July 5, 2010

The U.S. economy has had two crises that were followed by long periods of depressed economic activity, high unemployment, and instability lasting more than a decade—the Panic of 1873 and the Crash of 1929.

Conditions are emerging that could cause that to happen again, and without a radical change in policy, the nation is at risk of a terrible calamity.

The economy has many natural resuscitative qualities that usually return it to growth after it falters. During downturns, businesses run down inventories, and after a time, those must be restored. Efforts to slash costs go too far, and businesses begin investing again in critical equipment and software, and then some new hires.

Inventory rebuild, capital spending and some new jobs jumpstarts growth, and this pattern emerged from July 2009 through March or April of this year.

Now faltering retail sales, jobs creation and consumer confidence, and stubbornly high new unemployment claims, indicate the economic recovery may be quitting.

If the economy goes down a second time, now, its resuscitative qualities will have been spent when government deficits can't be much increased, and the Federal Reserve can't further cut interest rates.

If the economy goes down a second time—for example, GDP declines significantly two quarters in a row—then it likely goes down for good. Unemployment would rise into the teens, and the economy would sink into a depression—a deep and painful slump from which it cannot soon recover.

President Obama's policies are not helping.

More than one trillion dollars in stimulus was squandered, creating few jobs, and the President's spending commitments are not proving temporary. Instead, federal finances are burdened by indefinite annual deficits exceeding one trillion dollars—much worse than when George Bush left office.

Obama's health care reforms are long on mandated benefits and short on cost controls. This combination is raising insurance premiums for businesses and individuals, forcing state governments to increase taxes or trim other programs, and discouraging businesses from hiring.

The President touts green industries to radically reduce petroleum use and seeks to end much offshore drilling, but experts familiar with alternative energy technologies realize that windmills, solar panels, and converting crops to fuels won't appreciably reduce petroleum use for decades. Either Americans develop more domestic petroleum or pay dearly for more foreign oil.

Financial reforms moving through Congress will impose costly new regulations that raise the cost of credit, create few meaningful consumer protections that are not already being implemented by the Federal Reserve, and leave the biggest banks largely free to continue speculative activities, controlling an even larger share of the nation's deposits than before.

Big banks remain too big to fail and are becoming more dangerous.

Smaller banks are cash starved and burdened by assets made toxic by the crash—for example, mortgages on shopping malls that have too few customers.

Businesses need customers and capital to grow the economy and create jobs. The trade deficit—in particular, imports of oil and the trade imbalance with China—cuts huge holes in demand for U.S. goods and services. Without meaningfully addressing petroleum use and China, other efforts to create jobs are futile.

Detroit can build many more attractive and fuel-efficient vehicles now, but for union contracts and cumbersome regulations. A national policy to replace the existing fleet would reduce imports and create many jobs.

China's purposely undervalued yuan makes its products much cheaper on U.S. store shelves than its labor cost advantage require, destroying millions of U.S. jobs. China has rebuked diplomatic efforts by President's Bush and Obama to change this policy.

President Obama should counter Chinese protectionism and abuse of free trade with a tax on dollar-yuan conversions that raise prices of Chinese imports to their true cost to the U.S. economy.

A Savings and Loan Crisis era Resolution Trust could relieve regional banks of troubled loans, earn a profit for taxpayers, and give small and medium sized businesses adequate bank credit again.

Much of this runs counter to President Obama's progressive principals but hard realities, not utopian dreams, must dictate the decisions of a leader or his nation fail. ESR

Peter Morici is a professor at the Smith School of Business, University of Maryland School, and former Chief Economist at the U.S. International Trade Commission.





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