Little Hope for Quick Recovery

By Christopher Lingle

BALI, Indonesia ― As stock markets around the world beat a hasty retreat, a cautionary tale might be found by looking at the United States since it is ground zero for the current economic and financial upheavals.

While U.S. President Barack Obama is overseeing vast spending increases to stabilize the economy, the U.S. stock market is tanking while prices of long-term Treasuries continue to rise.

It is no coincidence that the Dow Jones Industrial Average (DJIA) ended the worst January in its 113-year history, down 31 percent.

Nor when the Dow had the worst February for blue chips since 1933, down another 120 points, while the S&P 500 declined by 2.4 percent. Now, after six consecutive monthly declines, the DJIA breached 7,000, sparking talk of a correction to 5,000.

Since markets are always forward-looking, share prices represent anticipated future earnings. Recent dismal performances show that investors do not like what lies ahead.

One element of the future perspective of stock markets is to capitalize the effects of government economic policies. As such, share prices can be expected to fall when current or anticipated policies are seen to lead to lower economic performance.

With recession long factored into stock market indexes, the ongoing retreat is signaling fear that Obama's policies will inflict great harm on the U.S. economy. Another harbinger of waning faith in the economic future is that gold prices began a sharp upward ascent starting in November 2008. Did someone say ``panic?''

One reason for economic dread from the Obama policy mix is the likelihood that elements of the stimulus package will become permanent. This will cause deficits to continue to be high or require higher taxes or both. Anyone believing otherwise will be either delusional or in denial.

President Obama's proposed federal budget is $3.6 trillion for next year, with a $1.75 trillion deficit that is nearly four times the highest in history.

This puts the proportion of GDP going to federal outlays in fiscal 2009 at 27.7 percent, the highest share of the economy in any year since 1945. The deficit would be 12.7 percent of GDP and is $250 billion more than earlier projections due to proposed new spending to bailout banks and other financial institutions.

Obama complains about inheriting a large deficit and that the national debt under Bush doubled. But under his watch, the current deficit will almost surely double and perhaps it will triple.

As it is, Congress is led by politicians with a penchant for increased regulation and more public-sector spending regardless of the size of deficits. And so, despite campaign promises to banish earmarks and recent entreaties to the Congress to exercise restraint, the most recent spending bill was heavily laden with pork.

But market players do not buy the hype and hubris in justifications for such an enormous increase in government spending and expanded controls over the U.S. economy. Following Obama's penchant for ``channeling'' Lincoln, he is finding that you cannot fool all of the people, all of the time.

For their part, the Obama team increased the climate of uncertainty to stampede the general public into accepting the stimulus package and the mushrooming deficit. While successful entrepreneurs can deal with uncertainty from market conditions and even thrive with it, uncertainty created by politicians tends to stifle business activity.

And so, fear-mongering and negative remarks about the economy to spook the electorate into supporting his spending plans have undermined overall confidence.

The one aspect of political certainty is that there will be more taxes on small businesses, on work and on capital investments.

And there will be new and costly burdens from taxes related to a cap-and-trade carbon emissions scheme and moving toward nationalized health care. All this will increase the size of government while the private economy shrinks.

As the private sector reels from recession, massive public-sector borrowing will force up interest rates and ``crowd out'' private investments. As private firms face higher borrowing costs, marginal investments that could create new jobs will not receive needed capital.

And then there is the elephant in the room that nobody wants to notice: rising price inflation. But myth making about this being a redux of the Great Depression induces the Federal Reserve to orient monetary policy toward warding off deflation.

But this is not your grandfather's recession. It is more like the one conjured up by Jimmy Carter. In a single term of office, President Carter oversaw double-digit inflation, double-digit unemployment, double-digit interest rates, shrinking incomes and increasing poverty.

As the Fed raised the federal-funds rate from 9 percent in July 1980 to 19.1 percent, the 30-year mortgage rate hit 18.45 percent.

With the Fed fighting the wrong enemy, the annual rate of growth of the money supply was about 20 percent since last September. With monetary spigots on full blast and pork-barrel politics in full cry, it can be said with near certainty that this will trigger rising domestic prices.

Given the dollar's pre-eminent role in global trade and finance, this could lead to globalized price inflation and lead to stagflation.

Regardless of the hand dealt to the Obama administration, he and his allies in Congress aim to increase the burden of taxation and regulation on a weakened economy. It is not surprising that his policies and the massive inflation of the money supply draw a thumb's down from the stock market, ending hope for a quick recovery.

Christopher Lingle is a research scholar at the Centre for Civil Society in New Delhi and visiting professor of economics at Universidad Francisco Marroquin in Guatemala. He can be reached at clingle@ufm.edu.