America's Economic Future: The Ineluctable Plunge

The subprime mortgage crisis has captured recent headlines in economic and financial reports. Unarguably, foreclosures and mortgage defaults have delivered a severe blow, one which threatens to send America's economy into recession. The upcoming election coupled with newfound fear of an economic slump puts the economy back into the forefronts of discussions, giving attention to more fundamental issues such as the devaluation of the dollar, national debt, and over consumption, topics which have been threatening the economy for years without receiving the same attention as the mortgage crisis. Though more thought has been given to the current state of our economy, it is not enough. Without proper fiscal and monetary guidance, America could potentially face conditions reminiscent of the 1930's. The weakening dollar will deter foreign funding of government bonds and eventually, assuming no miraculous influx of money, the national debt will force the government to cut expenditures, jeopardizing education, social programs, and other important services. The devaluation of the dollar will also pose serious financial dilemmas for American manufacturing companies who outsource their work as well as to consumers who will be forced to spend more money on goods. Given these impending issues, I have decided to probe blog posts discussing America's recent economic developments. The first post I decided to comment on was written by Tim Duy, an adjunct assistant professor in economics from the University of Oregon, but posted by his colleague Mark Thoma on the blog Economist's View. Tim Duy analyzes recent interest rate cuts to determine the Federal Reserve's current position on the economy and possible future implications. The second post I decided to comment on is by a retired economist strategist and International Monetary Fund employee, Desmond Lachman, and is hosted on a geopolitical web publication. Desmond touches on various factors threatening long term growth and provides a summative break down of each point. I submitted my comments to each blog and posted a copy below.

"Fed Watch: Fed Set to Cut Again, But Looking For a Chance to Pause" Comment:

The Federal Reserve does seem incapable of promoting the confidence required to rally people but I too want to believe. What I do believe, though, is that recent housing afflictions have aggravated and hastened an already serious problem in the economy and the Federal Reserve would be naive to believe interest cuts will remedy or divert the inevitable clash of several key economic complications. Bernanke's (right image) wishful tone when discussing future interest cuts (or should I say lack thereof) is "commendable" but also a blatant lie and a failed attempt at shaping market participant's beliefs, as your colleague noted. I enjoyed reading your colleagues piece and I found it very informative; however, though Tim is most likely correct about future interest cuts, I disagree on a couple points. The current interest rate at 3% will drop incrementally over several months, but the target 2% predicted by Tim appears as a shy estimate. American manufacturing and unemployment growth are far from impressive and given the housing market (including byproducts such as utilities and manufacturing) is approximately 10% of the GDP we can assume interest rates will drop closer to 1%. The Federal Reserve has tremendous pressure on its shoulders and if history is any indicator than such a decrease is almost certain. Additionally, I do not believe this will be "an end to end this cycle." Most likely, there will be economic tension more damaging than market correction under moderate interest cuts. The financial sector is already strained from red ink and even with interest cuts there will be hesitation in lending practices. On a more global level, Tim is right, other countries will want to avoid the high risk of inflation and stop funding America's debt. However, the "impact of past policy" will not be felt with much firmness by summer. Any threat of further decline will amplify economic weaknesses already present such as the devalued dollar and national debt. The economy will continue to rise and fall, but each fall will outweigh previous gains. Maybe the economic stimulation package will provide a silver lining, but most likely we will have to hope the next president will implement comparatively sound economic policy. This cycle has just begun.

"Bearing Down - The Coming Recession" Comment:

I agree very much with most of the points established in your post. And it is frightening to even suppose the similarities between Japan's 1990 economy (left image) and our own. The asset price bubble ballooned since the dot-com crash and the heavy reliance on the housing market for GDP growth has become painfully obvious. America is now stuck in a balancing act; the government has to find a way to deflate the bubble without crippling the economy. Unfortunately, I do not believe there is neat solution. At some point the market will correct itself and in our current state, an overabundance of fiscal and monetary policy may prove to be more detrimental than helpful. The government has to avoid worsening economic weaknesses, namely inflation. In fact, America would not even have to experience full fledged inflation to feel its repercussions. As soon as foreign entities detected unmanageable risk we would witness a rapid flight in funding. Though I agree the government has to react in some capacity, I am not sure I believe Bush and his administration "have finally grasped the urgency of the present situation." Or if they have, then another agenda is affecting their performance. The Federal Reserve is limited in its economic tools and the burden is on Congress and the Executive Branch to execute policy which will promote growth and tighten certain fiscal sectors. For example, I strongly believe temporary credit codes need to be implemented to begin counteracting the credit crunch and restricting plastic based consumption. Furthermore, immediate and aggressive policy to reinforce American jobs and production need to be established. Stimulating the economy from a monetary stand point, such as tax refunds, will not establish long term growth and will only delay the inevitable. That being said, how do you think current solutions will impact our economy in the long run? Do you believe it will provide a realistic opportunity in diverting massive recession? Or do you believe "we are due" given the many problems with our Economy? And finally, what types of changes need to be realized to insure long term stability?