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By Zheng LianSheng Translated By Edmond Lau
24 April 2012 Edited by Laurie Henneman @ Watching America
After the fourth quarter in 2011 the U.S. economy's resurgence exceeded the expectations of policy makers and the markets, especially the labor market. Faith was restored to many again as they looked forward to more growth in 2012 but the first quarter's numbers suggest that recovery can be tortuous. The heat is once again on the world's "central bank," the Federal Reserve, yet the Fed has no tricks left in dealing with the economy's turbulent recovery. Chairman Ben Bernanke is known for his honesty but even he has been evasive when asked about the situation. In truth the Fed is anxious that its policies are hanging by a thread, and fears the economy might meet its Waterloo soon.
Back in September 2011, Bernanke admitted that the U.S. economy was due to face another recession but this had little effect on the market's optimism about the economy's resuscitation. Ever since the fourth quarter in 2011 the economy has performed far better than predicted, especially the nation's employment situation. By the end of January 2012 an extra 275,000 non-agricultural jobs were created (the highest point in the last nine months) and this decreased the unemployment rate to 8.3 percent (the lowest in the last three years). The manufacturing sector has shown some serious recovery progress and this gave a huge boost to the stock market. The Nasdaq even reached a record high at one point. Americans had all the right reasons to be positive in regard to the recovery.
The revival in manufacturing and consumption sectors, as well as increased inventory investments, were the driving forces behind America's improved economic situation. The sharp increase of 4.3 percent in consumer credit in January 2012 was much higher than last January 2011's 3.6 percent. Retail performance also increased 0.8 percent, a superior rate comparing with the same month last year.
Industrial production in February also enjoyed an increase of 0.03 basis points, but new orders were still below the previous quarter. The manufacturing index also plummeted from 20.21 to 6.56, a much lower figure than Reuter's initial forecast of 18. Moreover the housing market has shown little signs of life during the last few months.
The U.S. economy's road to recovery won't be too risky, but do expect a bumpy ride. The International Monetary Fund believes there will be drags on the process such as the deadlock in fiscal consolidation policy, a weakened housing market, household saving rate fluctuations and possibility of a worsened economy. IMF Managing Director Christine Lagarde is positive about U.S. economy's chances of recovery, but its fragile foundation would affect the global economy's overall stability.
At present, there are three major risks that may disrupt America's healing progress.
The housing market has not seen its worst and better days are definitely not arriving soon. Data from the U.S. Department of Commerce showed that only 313,000 new housing units were sold during February, a 1.6 percent decrease in comparison to numbers from the previous month. New construction projects and current housing sales also dropped by 0.9 percent and 1.1 percent respectively. According to the Standard & Poor's home price index, housing prices in 10 major cities have dropped since January and the downward trend is expected to carry on for the rest of the quarter. The 2.8 million foreclosure cases is also a new high in years. Poor performance from the housing market and high foreclosure rate indicate that the U.S. mortgage market is still deleveraging.
Despite satisfying recovery progress the economy is still vulnerable to possible impacts from a high unemployment rate. As a result, the U.S. government has come up with a revival plan to ease job shortages in manufacturing. The market assumed an improved employment situation would eventually lead to better consumption rate. The forecast did not materialize however, when February's unemployment rate was an unconvincing 8.3 percent. It was once expected that by the end of the first quarter there should be 180,000 new non-agricultural positions created but the actual 120,000 figure was quite far behind. Former Nobel laureate in economics Joseph Stiglitz believes the country's current unemployed population is 15 million and it hasn't recovered to the point when the global economic crisis occurred in December 2008.
Massive public debt can be a sword of Damocles. The current deficit ratio and public debt ratio have hit an alarming 10 percent and 100 percent respectively, both exceeding the international safety standard of 3 percent and 60 percent respectively. The U.S. government has been making serious efforts trying to rebuild the economy after the global financial crisis broke out. It transformed private sector risks to public by taking on the private debts. It implemented quantitative easing to monetize public debt, but also risked inflation at the same time. The U.S. government is under immense debt pressure and it isn't too different from the catastrophe in Europe. Its credibility is on the line since the government's ability to free its debt is uncertain. Failure to repay may result in another insurmountable economic disaster.
A slow recovery and high unemployment rate forced the Fed to execute a second quantitative easing. Deflation in goods also gave the Fed the justification needed to carry out the policy. Hence at the start of this year the second quantitative easing experienced changes in its foundations. First, re-leveraging has been common within the private sector, and consumer credit may reach 4.3 percent within the first quarter. Secondly, America's consumer price index has been rising, with increases of 2.9 percent, 2.9 percent and 2.7 percent during the first three months of 2012. Instead of deflation these alarming numbers present possibilities for a troublesome inflation scenario, not in tune with the Fed's initial intention to sustain a 2 percent inflation rate. Finally, if anything, quantitative easing has shown its limitations as the boost is not enough to improve the job market situation and economic growth.
Under the current difficult circumstances the Fed will encounter a policy dilemma. America's weakened economy and high unemployment rate probably created a welcoming scenario for quantitative easing, especially during a counter-cyclical economic period. The Fed indicated earlier that they aimed to maintain low interest rates for another two years, until the end of 2014. Nevertheless, the general consensus in Wall Street is to expect a third round of quantitative easing due to unimpressive results in the first quarter.
The Feds are worried about the policy's side effects too. The policy's flexibility can be ineffectual considering that aggregate demand's continued slump could lead to a surplus of bills. Moreover, another factor that contributes to America's sluggish recovery relates to over-virtualization of finance and mortgages. The Fed has been applying monetary instruments to address the economic structural problems but the lack of effectiveness has not been encouraging. Thirdly, since the second quantitative easing mainly focused on long-term government bonds with the purpose of financing the budget deficit, this also means turning a blind eye on deficit ratio and allowing it to get out of control. Finally, running the same policy twice creates the U.S. economy's biggest "debtor" in the Fed. This would mean that the central bank has accumulated the financial risk and the nation's debt has fallen on their shoulders. The Fed itself has its own debt problem and the aggregate financial risk only assures an even more difficult path in the future.
The author has worked for the China Scholarship Council, Division of Planning and Development.
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