The question of whether the economy will continue to grow at a moderate rate, or slip into recession, comes down to whether the problems in the housing sector will spill over into the economy as a whole. If consumers have to rein in spending because they are no longer able to withdraw equity from their homes, or if the number of jobs lost in construction overwhelms gains in the service sector, the expected return to 3 percent growth by year-end will prove unattainable.
In that case, all eyes will be on the Federal Reserve Board’s monetary policy committee, which will be under pressure to cut interest rates. [Chairman Ben] Bernanke, however, is impervious to the sort of pressure brought by whinging businessmen and panicky politicians.
He has to worry about the inflationary effect of the falling dollar, which drives up the cost of imports and relieves some of the pressure on domestic manufacturers to keep prices down so as to meet foreign competition.
And that decline seems set to continue, precluding an interest-rate cut soon.
Meanwhile, higher inflation in Britain and the European Union will force the Bank of England and the European Central Bank to move rates up. That increases the attractiveness of non-dollar assets. Add the decision of some central banks to lighten up on their dollar holdings, and America’s persistent trade deficit, and you have a prescription for a further drop in the dollar. A $2.25 pound and a $1.45 or higher euro might well be in our future.
Which might be good news, although not for Europe’s manufacturers. Exporters will find it tougher to sell in the United States as prices of made-in-Europe goods rise in America, and European firms catering to their domestic markets will find their customers increasingly attracted to made-in-the-U.S. products. The world has been calling on spendthrift Americans to rein in their spending to reduce what are called “imbalances.” That’s just what will happen, proving once again that you should be careful what you wish for.
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