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Deflation and President Obama's legacy

By Peter Morici
web posted August 23, 2010

Deflation is coming and Americans should be alarmed.

Many, though hardly all, prices are falling.

Government regulations, subsidies and sanctioned monopolies make some price increases inevitable—the world may end before doctors' visits, prescription drugs, college tuition, and cable TV rates stop rising. For now, President Obama has legislated higher car prices and profits by removing large amounts of capacity at GM and Chrysler, offering subsidies for hybrid and electric vehicles, and imposing tougher fuel economy standards.

Even with those industries pulling up inflation, prices outside the erratic energy and food sectors—so called core inflation—have increased less than one percent over the last year.

Prices are falling for many discretionary items like furniture, apparel, personal computers and electronics, recreational and communications services, and personal care products. Real estate prices and rents remain in the pail.

Some deflation may not be bad if accompanied by decent growth—4 to 5 percent a year until unemployment comes down and 3 percent over the business cycle. That would discourage reckless lending better than any regulator. Treasury securities could still pay 1 to 2 percent a year, real interest commercial and mortgage rates at 3 or 4 percent would be aligned with long term growth, and borrowers hardly would be victims.

However, deflation is spreading, because Americans have been sold a false idea by Treasury Secretary Geithner: high unemployment and tepid growth are the new normal and desirable.

For the 24 months prior to the Great Recession, unemployment was less than 5 percent and optimism abounded that new technology would carry Americans into an age of cleaner energy, higher productivity and plenty.

If ineffective regulation caused the financial crisis, President Obama's reforms should have fixed the problem, and the economy should be able to grow fast enough to pull down unemployment to acceptable levels.

Americans are not wandering fools, heirs to a lost civilization. They can still make goods and services but demand for what they make is inadequate.

Consumers are buying again but not enough, because housing prices are depressed and many homeowners, crushed by high-interest mortgages, simply cannot refinance with prices depressed. Credit card companies are becoming the last refuge of the financial flimflam man.

Baby boomers are trimming spending and postponing retirement, because the stock market and their retirement accounts have not gained much value in more than a decade.

President Obama's health care reforms are pushing up insurance premiums and co-pays, and local governments are imposing new taxes, leaving consumers with much less to spend on everything else.

The trade deficit is growing again, and each additional dollar spent on imports that does not return to purchase U.S. exports reduces demand for what Americans make.

President Obama wants to double exports in five years, and is banking on emerging industries such as wind and solar generation and electric vehicle components. That will be tough because China is the fastest growing market, and the president refuses to meaningfully challenge its protectionist technology and procurement policies.

For example, China requires that state run wind farms purchase wind turbines with at least 70 percent domestic components and state owned farms are 80 percent of China's market. GE has superior technology and could export turbines and components from the United States but must produce in China to serve the market.

Doubling exports to China and elsewhere does no good if U.S. imports more than double.

In many industries, locating in China or India to gain access means exporting back to the United States with that capacity. And China's undervalued exchange rate and other export subsidies in industries ranging from tee-shirts to telecommunications equipment remain unanswered by President Obama.

A tax or restrictions on CO2 emissions, which the President has pledged to impose on U.S. industries but Beijing refuses to apply to Chinese competitors, would make matters worse

The housing and stock markets are not something President Obama can address directly, but he needs to rethink his health care, environmental and other regulatory policies, and trade with China.

If not, President Obama's legacy will be deflation and an America in economic decline.

A nation that can't grow enough to take of its elderly, educate its young or provide a decent future for anyone but Wall Street financiers, Hollywood stars and Washington's policy elite. 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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