September 27, 2012

The Great Train Wreck

For those who might have nodded off during Econ 101, the Federal Reserve controls the nation's monetary policy: the cost of money (interest) and the amount and flow of money through our nation's banks into the economy. The Congress (not President Obama) controls fiscal policy: how much and in what manner the federal government spends money in order to expand or contract the economy.

In a recession, traditional fiscal policy calls for lowering taxes and increasing government spending. Monetary policy calls for lowering interest rates and increasing the money supply. Taken together, they should jump-start a spluttering economy. Trouble is, we've been doing that, and it hasn't made much of a dent. So the question becomes what do we do next.

I've often said that my biggest fear is that no one knows what to do about the economy. Turns out I'm not the only one. Here is a quote from Richard Fisher, President of the Federal Reserve Bank of Dallas, speaking about getting the economy back on its feet:
"We can easily conjure up plausible theories as to what we will do when it comes to our next tack or eventually reversing course. The truth, however, is that nobody on the committee, nor on our staffs at the Board of Governors and the 12 Banks, really knows what is holding back the economy. Nobody really knows what will work to get the economy back on course. And nobody – in fact, no central bank anywhere on the planet – has the experience of successfully navigating a return home from the place in which we now find ourselves. No central bank – not, at least, the Federal Reserve – has ever been on this cruise before."
Those discouraging words came during the debate over the recent decision by the Federal Reserve to buy $40 billion of mortgage debt a month from now until whenever and also to keep interest rates low until at least mid-2015. This is being matched by an emerging consensus in Europe to have the European Central Bank soak up all the sovereign debt that is currently sinking the economies of several of its countries

In essence, the central bankers in America and Europe have committed to buying our way out of the problem. Will it work? Who knows? It is a gigantic leap of faith, one that has no Plan B. That's what's really scary. If this doesn't work, then there is no choice but to let events run their course, and that could get very ugly.

The next big break point is Taxmegeddon, a train wreck set in motion by Congress's penchant for putting off problems to the bitter end. The crisis over raising the debt ceiling resulted in a binding agreement to inflict equally deep cuts on defense and domestic spending. That train is rushing headlong towards another train, the Bush tax cuts (and some payroll tax cuts), which expire at the end of the year.

Everyone agrees this train wreck will hurt the economy. No one agrees on how to avoid it. The Republicans and the Tea Party want to leave the defense cuts and keep the domestic cuts and all of the Bush tax cuts. The president wants to eliminate tax cuts for the wealthiest. Sound familiar?

Here's the kicker. Taxmegeddon is a problem with a known crunch time. On January 1st, the Bush tax cuts expire and a budget deal that nobody wants goes into effect. So somehow, between Election Day and the end of the year, Congress and President Obama will have to find common ground or else we will all take a great fall over the edge of the fiscal cliff, and all the Federal Reserve Bank's monetary horses and men won't be able to put the economy back together again.

Let me ask you. Do you believe in miracles?

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