Paying the Political Piper

It is difficult to imagine a time when the future course of the economy was due to be so heavily influenced by unpredictable events, and by the decisions of policymakers. For one thing, there are those known unknowns: Iran might explode a nuclear device or Israel might take steps to make that impossible; Islamic terrorists might succeed in an attack on some major financial centre, or on the Saudi oil fields.

An even greater source of uncertainty comes courtesy of the President and the chairman of the Federal Reserve Board. In 2009 Obama poured gallons of red ink all over the nation’s ledgers, while Fed chairman Ben Bernanke printed money with which to buy up Obama’s IOUs. Now, there are hints that both will reverse course, this year. The President says he plans to rein in spending in the long run, which of course is not quite the same thing as doing it now. And the Fed is hinting at the various techniques available to it to sop up the excess liquidity with which it has flooded the system, when it decides the time is right. Guess right on how Obama and Bernanke will see things, and you have a winning economic prediction.

The safest guess is that the President and the Democratic congress will continue to run up the budget deficit. The House already has passed a second stimulus that dare not speak its name, and the President will soon sign a health care bill that will spill more red ink over the nation’s ledgers. Then comes an energy bill.

Meanwhile, the Fed has made it clear that so long as the unemployment rate stays high, and the financial and housing markets remain fragile, it will not tighten, at least not a lot. Critics of the President and the Fed argue that all of this is for naught. The unemployment rate has risen from 7.6 percent at the beginning of the year to 10 percent, the number of long-term unemployed has doubled to almost six million, foreclosures mount, and hundreds of banks have failed.

To which the response is: because of all these policies the financial system did not collapse, job losses are tapering off, the housing market is firming up a bit, and even the bloodied dollar is showing signs of strength.

My own guess is that all of this means that 2010 will see a continued recovery, and one more rapid than most observers are expecting. Consumers seem to have unzipped their purses late in the Christmas shopping season despite the absence of the deep discounting of recent years. Share prices are up, and investors cheerier, in part because they don’t take account of inflation when toting up their gains: factor inflation in, and it will take a further share price rise of 25%-30% to get them even with 1999 levels.

The important housing sector seems to have bottomed out, with sales of existing homes and prices both up a bit. But here is where policy--difficult to forecast--becomes crucial. If the congress allows existing tax credits for first-time buyers to lapse, and the Fed reduces its several supports for the mortgage market as it says it will, mortgage rates will rise, perhaps enough to abort a housing recovery that is fragile at best. Both programs are scheduled to end early this year, shortly before voters decide the fates of all members of the House of Representatives and onethird of senators. It is anyone’s guess whether they will risk allowing these programs to die, and with them their careers in public office.

None of this is to say that policymaking is all that matters. Consumers account for some 70 percent of U.S. economic activity, and in the end are the ones whose reactions to policies will drive the economy. So it is good news that personal incomes and wages rose last month.

Businesses, too, matter. Right now profits are good, and they are sitting on a pile of cash. But uncertainty as to the cost to be imposed upon them by the new health care “reform,” the impending carbon cap-and-trade bill, and by the prospect of a huge boost in their tax bills, makes them reluctant to invest and to hire.

So look for a better 2010--with the piper for all this spending to be paid at a later date.

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.