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POLITICAL ECONOMY
Outside View: Pressures mount on Fed, ECB
by Peter Morici
College Park, Md. (UPI) Aug 1, 2012


disclaimer: image is for illustration purposes only

Pressure mounts on the Federal Reserve and European Central Bank to avert another recession but neither can accomplish much without their governments pursuing more competent economic policies.

In the United States, unemployment hangs at more than 8 percent and a second recession threatens because too much of what Americans spend goes abroad without returning to purchase U.S. exports.

Demand for U.S. products is burdened by huge trade deficits on oil and consumer goods with China -- totaling about $600 billion each year.

Congress and U.S. President Barack Obama have significantly curtailed production of oil offshore and in Alaska, doubling the oil-import deficit.

And both refuse calls from economists across the ideological spectrum to force China to stop manipulating its currency, imposing punitive tariffs on U.S. products and subsidizing exports.

Consumer and investment spending are flagging but the Fed has few levers left. A statement that it intends to keep short-term interest rates near zero beyond 2014 would have little impact on investor psychology -- already, few expect the Fed to push up rates in the foreseeable future.

A new round of bond purchases to push down long-term Treasury and mortgage rates are on the table. However, over the last several months, investors have moved cash from risky European government and corporate securities to U.S. bonds. The 30-year Treasury and mortgage rates are near record lows, pre-empting the effectiveness of any additional Fed measures.

Boosting U.S. oil production and earnestly confronting Chinese mercantilism would boost demand, double gross domestic product growth and create 5 million jobs but those actions are beyond the Fed's purview.

ECB President Mario Draghi has promised to do whatever it takes to save the euro but the architecture of the single currency is even more flawed than policy in Washington.

Like Florida, Spain boosts a significant resort industry and when the recession hit real estate values plummeted and loans failed much more than elsewhere. The Fed stood behind Florida banks and Washington continued to finance Social Security, Medicare and unemployment benefits. Spain's central bank can't print money and Madrid was forced to borrow more than capital markets judged prudent to shore up its banks and maintain its safety net.

Required cuts in government spending set loose a downward spiral of falling GDP and tax revenues, rising interest rates on government debt and more cuts -- now Madrid tumbles toward insolvency.

Italy and Greece have wages too high and labor laws too cumbersome, making much of their economies uncompetitive. Large trade deficits with Germany, and borrowing to finance those, ultimately caused capital markets to lose confidence.

Labor market reforms aren't enough -- wages must fall dramatically, perhaps as much as 30-50 percent. Such internal devaluation isn't possible when workers have mortgages and other debts denominated in euro.

Even if the Mediterranean states had their own currencies, those would surely be falling now against other currencies. Workers would be able to buy fewer foreign products but they would better able to make goods for export and make loan payments in pesetas, lira and drachma.

The ECB could wink and lend billions to Spanish banks against bad real estate loans, and buy government debt that will never be repaid but collectively Mediterranean governments need to shed some $2.5 trillion in debt to become solvent. The ECB can't purchase and forgo interest payments on that much bad paper without completely destroying the confidence of international investors in European financial institutions.

Central bank policy can help dampen inflation when an economy overheats and lift borrowing, investment and home sales a bit when it falters but it can't save economies when national governments pursue flawed economic policies to serve political objectives.

Both the Fed and ECB policymaking committees meet this week but they can do little to avert a recession.

(Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, and widely published columnist.)

(United Press International's "Outside View" commentaries are written by outside contributors who specialize in a variety of important issues. The views expressed do not necessarily reflect those of United Press International. In the interests of creating an open forum, original submissions are invited.)

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