Chicken Soup for the U.S. Economy

A head cold lasts a week if you treat it, seven days if you don’t. Chicken soup often makes one feel better, as do some medications, but they do nothing to cure an illness caused by a constantly mutating virus. A cold’s symptoms, the sneezing, runny nose and congestion which make one feel miserable, are not caused by the infecting virus, but, in fact, by the defense mechanisms employed by the body to rid itself of the infection.

The U.S. economy has caught cold, and it will last the usual amount of time, about half a year for a mild case. Symptoms only now are beginning to be evident: slowing economic growth, rising unemployment and jobless claims, a weakening dollar and falling asset prices in residential real estate and the stock market. The Federal Reserve is ladling out economic chicken soup as fast as it can in the form of liquidity injections and slashed fed funds target rates, but the economy still is starting to feel lousy.

We view the current recession as that seven-day cold (and it sure seems like we’re in a mild one now, with preliminary 4^th Quarter 2007 GDP falling to +0.6%). Annoying, frustrating and to be ignored only at a greater risk of developing something far worse from a weakened immune system, but not something to be overtreated. But, of all the luck, we’re in the middle of an election year.

And so we are seeing a concerted effort to “treat” the symptoms which have been caused by the economy’s own infection-fighting mechanism designed to wring excesses from the system. The Fed and the U.S. Treasury have run to the Congressional drug store for a strong dose of good-old-fashioned fiscal stimulus, which may mask some of these symptoms but will do nothing to cure the disorder. That the economy must do for itself. Whether it can, or lapses into something worse, is the trillion-dollar question.

The proposed $150 billion or so tax rebate, a moderate “helicopter drop” of money on the U.S. economy, won’t take effect until summer, but unless patients follow the dosage instructions exactly and spend every dime of their rebate checks instead of saving the money or paying down debt, this over-the-counter medication will have little effect. (Alternatively, it could protract the illness since all $150 billion must be borrowed, increasing the budget deficit and adding to $9.2 trillion of national debt. About half will be borrowed from foreigners, and if we buy imported merchandise, including imported oil, there is some debate as to exactly whose economy ultimately is being stimulated.)

As former Fed chief Alan Greenspan observed in unusually understandable English nearly a year ago, economies are cyclical and, all things considered, given the duration of the current U.S. expansion (since early 2002) “we are in the later stages of a cycle.” The “maestro of money” then gave one-in-three odds of a U.S. recession by year-end 2007, which now looks like a winning bet.

On occasion, cures may be worse than the illness, so we must be vigilant for other symptoms of a worsening condition, namely stagflation. Once thought eradicated by central bankers, as no cases have been observed since the mid-1970s, stagflation could make a virulent comeback, if commodity price increases escalate out-of-hand, affecting not only us, but other economies as well.

Some think the Fed should prescribe Dr. Volcker’s patented cold-turkey economic shock therapy, a dire treatment which calls for much higher interest rates and constricted money supply, resulting in an immediate depressionary deflation: crashing asset prices, high unemployment, a stronger dollar, widespread bankruptcies and financial sector failures. It has not been prescribed since 1980.

But as one economist recently observed, “When a man is in the middle of a heart attack, don’t lecture him about his diet. Fix him, get him on his feet again and then try to modify his habits. Mr. Bernanke’s Federal Reserve likely will not reach for Dr. Volcker’s inflation-fighting tonic, believing wholesale asset deflation to be a far more sinister malady than the present ailment.

Let’s wait and see the Fed seems to be saying. Take a tax rebate, two more rate cuts, get plenty of liquidity and call us in October. And don’t forget the trip to Disneyland after you receive your check this summer, the economy is depending upon you.

Coordinated, ongoing efforts by the Federal Reserve, the Treasury, Congress and the Administration to “do something” about the economy may mask emerging recessionary symptoms. If mild and if, in fact, it already has begun, we’ll only know it was a textbook recession officially long after the fact, perhaps closer to election day or after a new president is inaugurated.

If we are at the beginning of something more serious, say an economic heart attack, more potent medicines such as Dr. Volcker’s elixir, despite its foul taste and terrible side effects, may be necessary to shake off a quarter-century of accumulated bad fiscal habits. It would be the unthinkable, and yet could be the first crisis of a new presidency.