I Hope I'm Wrong

As I read the news and listen to the commentators I begin to fear that a prediction I made during the election campaign of 2010 will come true. At the time I told those who asked for a forecast:"...if the Tea Party gains significant control in the new congress we can expect 14% unemployment by the time of the 2012 election." I based my conclusion on a belief, which has proven itself in the recent debt ceiling debate, that right wing obstructionism would prevent any governmental ability to bring us out of the economic doldrums.

I pointed out, at the time, that the bulk of the stimulus ended up replacing tax income that state and local governments lost during the recession; with the expiration of the stimulus spending and the subsequent cuts in state and local spending accomplished through layoffs we could expect to see a rise in unemployment and a possible double dip recession. As we have seen, the new debt ceiling legislation not only eliminates the renewal of the stimulus package, but it also cuts additional spending from the federal budget. This lowered level of spending means that there will be fewer jobs in many different sectors with a subsequent reduction in consumer spending. In addition, extended unemployment benefits have also been eliminated. Unemployment benefits act as an automatic stabilizer in that they allow the unemployed to maintain at least a minimal level of spending.

The evidence that my prediction for an economic downturn may come true came in yesterday's announcement that worker productivity dropped and today' announcement by the FED that economic growth has been less robust than they had thought.A reduction in productivity is usually an indicator that firms will be laying off more people. It is a sign that they have more workers than they need. If we add slower economic growth and state and local layoffs to this scenario it is not unreasonable to expect growth to turn negative. Given the prevailing attitude in the House of Representatives getting any type of government stimulus into effect will be virtually impossible. In the absence of government intervention to stabilize the economy we can expect an accelerated downturn.

Some might ask what the FED can do. Bernanke has said the FED will do all in its power to stabilize the economy. The problem is that the Fed's greatest tool is the ability to raise and lower interest rates. The problem is that lowering interest rates is a method of stimulating business investment and consumer purchases of homes of durable goods. Business investment is not only dependent upon the interest rate but is also dependent upon demand for the goods and services produced. If consumers are not working, or expect that hey might be laid off, they will not be buying durable goods and houses. As a result the demand that is necessary to set off business investment will not be there. Add to this the fact that banks might not want to lend if they foresee a downturn. Excess reserves, funds that banks can lend, are already extremely high and in the event that bankers are less than enthusiastic about economic prospects can go higher.

All in all, the more I observe about what is going on the more pessimistic I get. I truly hope that I am wrong and that somehow our elected representatives will wake up and do the right thing as opposed to the dogmatic. If so my predictions would not come true. If they follow the current course there is a high probability that I will be right.