The housing market is weighed down with unsold inventory, oil prices flirt with $100 per barrel, the dollar spirals downward, food prices spiral upward, and interest rates on millions of mortgages are about to be reset at levels that owners might not be able to pay.
That’s the semi-bad news. The really bad news comes from the financial markets, where estimates of losses due to subprime and similar mortgages have been raised from $200 billion to $300 billion in only a few days. Beset by such losses, a credit crunch and a threat that last year’s Christmas bonus pool of $37 billion might be off a billion or two, bankers and brokers are urging the Federal Reserve to lower interest rates lest the entire financial system comes crashing down.
The Fed is not so sure. It does believe the economy is slowing. But Ben Bernanke & Co. believes that the economy is still likely to grow at somewhere between 1.8 percent and 2.5 percent next year. A slowdown, yes, but not necessarily one calling for the drastic interest rate cuts the panicked bankers say are needed to avoid a meltdown of the entire financial system.
The Fed seems to think that the risk of inflation is just as great as the risk of financial disaster. Oil prices are not the only ones flashing warning signs. Food prices are also moving up at an annual rate of something like 6 percent. This combination of higher food and energy prices has sufficiently raised inflationaryexpectations — up from 1.9 percent in September to 2.4 percent — to scare lenders into demanding returns on bonds high enough to stifle lending, consumer spending and business investment.
Besides, interest rate cuts will accelerate the downward dive of the dollar. Foreign countries hold an estimated $3.7 trillion of their reserves in our currency. China alone holds well over $900 billion in greenbacks — and rising. The global purchasing power of these dollar reserves is shrinking, posing a dilemma for foreigners holding U.S. assets. Should they hold on to the dollars and face further losses, or start selling dollars and accelerate the pace of the greenbacks’ decline?
Bernanke & Co. knows that a rate cut might put further pressure on the dollar, which would please U.S. exporters but further upset holders of dollar assets. Chinese Premier Wen Jiabao has already expressed concern about the shrinking value of his country’s vaults full of dollars, and Middle East oil producers are wondering whether to follow the lead of Kuwait and abandon the dollar as their benchmark currency. If confidence in the greenback deteriorates further, dollar dumping might replace the recent downward drift and start the protectionist war with which French President Nikolas Sarkozy threatened the U.S. Congress.
But doom and gloom is only part of the story. The gyrating stock market has indeed plunged, but only to the level it was when we took time off from work in 2006 to give Thanksgiving for our myriad blessings. And the value of our homes remains well above the wildest dreams of avarice of all save the newest buyers.
Which may be why businessmen on the economy’s front line seem more optimistic about 2008 than do their bankers. Investment bankers tell me their clients are optimistic about their prospects. At a closed meeting of top CEOs, the vast majority said they expect double-digit growth in earnings in 2008.
And this was before bargain-hungry consumers descended on the stores Friday. Most forecasters had been hoping that sales would be equal to last year’s; the optimists were predicting a 4 percent rise. ShopperTrak, which tracks sales at more than 50,000 stores, reports that storekeepers were all smiles after a long, hard day swiping credit cards: Sales were up 8.3 percent over last year.
The interesting fact buried in these numbers is that almost all of the increase occurred in stores that cater to low- and middle-income consumers, who are supposed to be under the greatest strain from high gasoline prices and mortgage rate resets. The truly affluent, not interested in the bargains on offer, will show up later in the shopping season.
So the Fed is caught between the Scylla of threatened inflation and the Charybdis of an impending downturn. Lower rates and risk inflation in an economy that might not be slowing as much as the bankers think; hold steady and risk bringing credit markets to a screeching halt, triggering a recession.
So the Fed has decided that it can avoid both dangers and pilot the economy to the safety of a soft landing by adopting what it calls “appropriate monetary policy.” When the Fed meets on Dec. 11, we will find out just what that means.
Examiner columnist Irwin Stelzer is a senior fellow and director of The Hudson’s Institute’s Center for Economic Policy.
