Dr Peter Morici: Fixing markets and US economy must begin in the Oval Office
By Professor Peter Morici
Aug 11, 2011 - 6:49 AM

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President Barack Obama walks across the South Lawn of the White House before departing for Camp David, Aug. 05, 2011.

Dr Peter Morici: The US economy and equity markets are being rocked by a crisis of confidence. Businesses, investors and ordinary Americans simply lack confidence in the ability of the Obama Administration to get the country growing and create jobs.

Apprehension about the future stems not merely from the constant bickering between Republicans and Democrats on spending and taxes, but more fundamentally on the growing realization that monetary policy is spent - -   the Federal Reserve has some ammunition left but is not likely to be very potent. And fiscal policy - - huge stimulus spending and deficits championed by President Obama - - has failed to jump start growth and jobs creation.

The Federal Reserve cannot lower further short-term interest rates. The overnight bank borrowing rate (federal funds rate) has been keep near zero since December 2008, and additional Fed purchases of US securities to lower longer term Treasury and mortgage rates wouldn’t have much impact.

Fed purchases put additional funds at the disposal of banks but ordinary Americans can’t borrow because they lack collateral - - their homes are simply not worth enough to warrant refinancing at lower rates. Too many older families are locked into properties valued at less than their mortgages and can’t sell to younger couples and get more capital in circulation.

Banks make loans to businesses on the basis of cash flow not collateral—after all the equipment and structures of businesses lose half their value if those fail and can’t pay their debts. Simply, most small and medium sized businesses lack the additional demand and cash flow necessary to justify expansion and qualify for credit.

Economists can quarrel about how many jobs the stimulus saved, but a $1.6trn dollar deficit can’t be increased any further. The bond market won’t tolerate it, and now the whole political dynamic is to push to deficit down.

Congress quarrelling with the S&P about the calculations supporting its downgrade of US debt reminds of a class that went partying the night before an exam—it drank too much, got bad grades and now says the test is unfair.

Few rational observers would argue against the notion that the Congress is spending beyond the country’s means. Hence, little additional money can be found for additional stimulus from the public trough.

The third instrument of macroeconomic policy is exchange rates—the values the dollar trades at against other currencies.  A cheaper dollar would boost exports; reduce imports in favor of domestic products; and increase demand, growth and jobs creation. Europe and North American countries have forsaken exchange rates as a policy tool and growth strategy, but not so China, Japan, India, and others, who use exchange rates aggressively to their benefit and the peril of western economies.

Asian superpowers intervene in currency markets—regulate transactions and sell their currencies for US dollars—to keep their currencies cheap, boost their exports and growth, and deprive US and EU businesses and workers of customers and jobs.

With monetary policy and fiscal policy spent, exchange rates are only tool the United States has left, and that is the province of Treasury Secretary Timothy Geithner and the President.

Mr. Geithner argues that China’s intransigence on yuan pegging is not a problem, because China’s inflation is making its products more expensive. That is a sad apology for the failure of his diplomacy with Beijing to win changes in Chinese policies.

The yuan is undervalued by at least 40%, and its intrinsic value increases at least 6% each year because of Chinese productivity growth. With Chinese inflation exceeding US inflation by only 3 percentage points, it is hard to see how Chinese inflation will provide any relief.

Decisive action is needed now to counter currency manipulation by China, Japan and others - - these could include US counter intervention in currency markets, currency conversion taxes and licensing currency transactions to offset similar practices by those mercantilists.

All this requires major shifts in US policy, and for the President to articulate a clear path for Congress to support and for his Administration to implement.

Failing to make these changes would greatly imperil prospects for economic recovery and his reelection.

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Dow Closes Down 4.64%:

Peter Morici,

Professor, Robert H. Smith School of Business, University of Maryland,

College Park, MD 20742-1815,

703 549 4338 Phone

703 618 4338 Cell Phone

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