Uncle Sam Has Lost His Clout Over Economy
A couple of events in the past 10 days provide dramatic evidence of something many of us have a problem grasping: the United States has a lot less control over its internal economic affairs than we had come to expect.
We grew up thinking that the government, if it only got its act together, could shape trends with some confidence. Lower taxes and deficit spending would stimulate things if needed. The Federal Reserve Board, with any resolve, could keep some control over interest rates and thus the economy.
Those powers are still there, but for the moment at least, they are badly neutralized.
The first of the two events in question was the statement to Congress by Fed Chairman Paul A. Volcker that the Fed has abandoned growth targets for M1, the basic measure of the money supply. He called M1, which measures the amount of cash and balances in checking accounts, no longer a reliable guide to what is going on in the economy. He may be right, but he is masking how little the Fed can really do currently to get control of the money supply.
The second event was last weekend’s six-nation agreement to stabilize the dollar and take steps to reduce the U.S. trade deficit. The words were strong, but like past multination currency agreements, the plan lacks a reliable method of implementation. In short, the six nations probably are right where the Fed is--reduced to watching more than acting.
Most of this helplessness can be blamed on past mistakes. But a more useful exercise is to examine how the current state of the world economy limits what governments can do. Then, perhaps, we will lower our expectations about government and realize how much patience is going to be required for all the problems to be sorted out.
The first thing that should be recognized is that sluggish economies are often sluggish for good reason. After years of pell-mell growth through most of the world, much of it paid for through public and private debt, a day of reckoning has arrived. Debt simply can’t grow like that forever.
Purchase Satisfied
In much of the Western world, a lot of the demand for the goods that the debt was used to purchase has been satisfied. The market is more a replacement market than a growth market. In the less developed nations, borrowing made possible a lot of economic growth and that in turn powered the developed world as well. It meant healthy demand for Western goods. It helped the banks build loan volume. Now it is clear that this sort of artificially stimulated growth doesn’t produce enough in revenue and profit to pay the debt back.
A second factor is that inflation has become so moderate that it no longer propels consumption like it did. There is no fear of rising prices to stimulate demand. With demand so cool, there is less sensitivity to changes in interest rates, the Fed’s main handle on the economy. The Fed played its interest rate card so powerfully a few years ago that it managed to push the economy into a nose dive and break an inflationary spiral.
What can the Fed do now? If it wants a stronger dollar, it can try to push interest rates up, but with loan demand in this country already soft, there is no guarantee that it can succeed. The move would only weaken the U. S. economy, affecting economic growth elsewhere in the world.
That is the problem facing the six nations. They agreed to attempt to keep the value of the dollar from slumping any more. Yet the main tool is for five of the nations to stimulate economic543650415from the United States. They can attempt to do that through tax cuts or through deficit spending. Yet it will be like pushing on one end of a string because the spending spree has run its course there just as it has in the United States.
What we are learning from all of this is that governments have a limited number of cards to play. And with the economies of individual nations so interwined with those of others, playing those cards becomes increasingly difficult.
So for the time being, the role of government is mostly reactive: stepping in to save a bank or a pension fund, or to buy time when Brazil can’t or won’t pay its debt. The economy is very much on its own.
