Will America Suffer a Lost Decade?

Perhaps the most important question being asked now that we have avoided a melt-down of the world’s financial system is, “Will America lead the world out of recession into a new era of economic growth, or will we suffer through a “lost decade,” which was Japan’s unfortunate experience after its credit crisis”?

The sort of decade in store for us, and for the world in which the America economy bulks so large, will be determined more by government policy than by economic forces. Economics will matter, but only as it is affected by government action. Consider this:

We are not trying to forecast whether General Motors can turn out cars that consumers will like, but whether the small, fuel-efficient cars its government owners order it to turn out will prove saleable.

We are not trying to figure out whether energy costs will rise or fall with market forces, and with the decisions of electric suppliers as to how best to produce electricity, but whether the costs imposed by cap-and-trade and “green” renewables will be so high as to burden already over-stretched consumers and add to our export woes.

We are not trying to decide whether economic forces will restore balance to trade between America and China, but whether our in-hock-to-China government can persuade the Chinese to stop manipulating their currency so as to encourage its export industries.

So mere economics cannot take us very far in the game of will-we-have-alost decade. But it can help a little. We know that tax rates in America will have to go up to pay for the current spending spree. We know that the higher taxes will be levied on what President Obama calls “the rich.” We know that will discourage new business and entrepreneurs. But we also know that neither wars, nor plagues, nor floods, nor mistaken policies have ever succeeded in discouraging American entrepreneurs from taking the risks essential to continued material progress. My guess, and it is just that, is that they -- and we -- shall once again overcome. But that’s more theology and ideology than economics. Or call it hope informed by experience.

We also know that we just might -- only, might -- be able to avoid inflation if Fed Chairman Ben Bernanke implements the “exit strategy” that he has been explaining to Congress and at town hall meetings. His plan is sensible: gradually withdraw the extra liquidity he has pumped into the system as soon as there are signs of a durable recovery. For that strategy to work three things have to happen.

First, Bernanke has to know when to implement it. Move too soon, and the tightening of credit would abort any recovery; move too late, and inflationary expectations will take hold. He might wait too long, since his study of the economy’s relapse in the mid-1930s after it began to recover from the Great Depression convinced him that the Fed tightened too soon, prolonging the Great Depression.

The second thing Bernanke will have to do is make clear that he really means it when he says that the longer the President and Congress continue to pour red ink across the nation’s books, the sooner the Fed will have to offset the inflationary effect of those deficits by raising interest rates.

Which brings us to the third thing Bernanke will need if he is to implement his strategy -- reappointment as Chairman when his term expires at the end of January of next year. Obama would not be pleased if the Fed began to tighten before his own re-election run, and has his top economic adviser, Larry Summers, ready, willing, and some say able to take over the running of the Fed.

My guess is that Bernanke is the sort who will talk truth to power even at the risk of his job. But he would be playing high-risk poker with a President who won’t hesitate to slip Summers, who so far has been a willing public advocate for much policy nonsense, into the chairman’s seat. Whether a safely appointed Larry Summers would turn out to be Obama’s Thomas Beckett no one knows.

Dr. Stelzer, director of economic policy studies at the Hudson Institute, is a columnist for the Sunday Times of London. A former managing director of investment banking firm Rothschild, Inc., he earned his doctorate in economics from Cornell.