After a seemingly endless transition period, US President Barack Obama has a daunting to-do list as he finally takes office. He inherits an economy where the recession is deepening daily, the banking system is shot, the Detroit car industry is in effect bankrupt, the housing market is in an advanced state of meltdown and the budget deficit is going through the roof even before he announces a US$800 billion stimulus package.
He is having trouble getting his choice of treasury secretary, Tim Geithner, approved by Congress because of questions being asked about his tax affairs and the work papers for a domestic employee.
Geithner’s expertise as the former head of the New York branch of the US Federal Reserve is needed at a time when Wall Street has lurched back into crisis mode.
Since August 2007, there has been a distinct rhythm to events: bursts of turmoil followed by weeks or months of beguiling tranquillity.
Last week’s fresh US$20 billion bail-out of Bank of America and the rumors surrounding Citigroup marked the end of the rally that followed the market mayhem of the autumn.
To make matters worse, he is expected to solve all these problems — and more — instantly. Not since former US president Franklin Roosevelt was sworn in, in March 1933, has the in-tray been so full; it is unlikely even FDR carried Obama’s crushing burden of expectations.
If the US believes that the new president can solve his economic problems in a whirlwind of activity that apes Roosevelt’s first 100 days 76 years ago, it is in for a rude awakening.
By 1933, the US was past the nadir of the Great Depression, although few realized that at the time. Most of the recent evidence — be it jobs, real estate, consumer spending, industrial output — suggests that Obama takes over with the economy still going backwards.
The new president is aware that he can’t do everything. He will make the economy his priority, putting some issues on the back-burner and leaving others in the hands of senior members of the Cabinet. It is improbable that Obama will take personal control of the situation in Gaza or of plans to reform health care. Those who believe that the president’s Kenyan roots will reap an instant dividend in terms of a huge increase in US spending on development are likely to be disappointed. While there is no evidence that Obama will renege on his pledge to double aid, the timetable for doing so has already slipped.
Making the economy a priority makes sense. US Secretary of State Hilary Clinton will be able to advise her boss on the perils of a lack of focus in the honeymoon period of his presidency, because that is what left her husband, former US president Bill Clinton, hamstrung after his inauguration in 1993. If Obama can get the economy right, he will have both the money and the moral authority to fix all the other problems. If he can’t, nothing else he does will really matter.
This is going to prove tougher than it sounds. As the crisis of the past 18 months has unfolded, policymakers have had to confront the fact that this is a downturn entirely different in its origins from any other in the post-war era. As Stephen Lewis of Monument Securities said, other contractions since 1945 were the result of a temporary mismatch between demand and supply. This one has been caused by a breakdown in the financial system that has unleashed wealth destruction on a colossal scale.
Central banks and finance ministries knew how to handle the traditional sort of crisis: they jacked up interest rates to deal with the overheating and cut them once inflation had been purged from the system.
They are still struggling to find a way to unblock credit channels when it is clear that the financial system is still at death’s door.
The US briefly flirted with the “nature’s cure” option when it allowed Lehman Brothers to go to the wall in September, but the ensuing mayhem means it is unlikely to try that cure again. Instead, policymakers — not just in the US but around the globe — are moving bit by bit towards the other extreme of full-scale nationalization.
Though this is proving the toughest of nuts to crack, it at least falls into the category of a “known unknown,” since it must be pellucid to even the slowest of policymakers that there will be no lasting or meaningful economic recovery while the root cause of the problem remains.
If it was possible to identify the “unknown unknowns” they would not be unknown, but it is possible to speculate on what they might be. One is that the collapse in global energy prices leads to economic — and eventually political — crises in the more vulnerable producer nations.
Iran and Venezuela fall into this category, but so does Russia, where last week’s series of rouble devaluations provided evidence of just how dependent the economy is on high oil and gas prices.
Stripped of the windfall from its energy sector, Russia’s lack of diversification and industrial inefficiency is being laid bare: hence the attempts to push down the value of the currency. Russia’s spat with Ukraine highlights how the economics of energy can quickly turn into geo-political tension.
An even bigger potential threat to Obama comes from China, where the government is struggling to cope with a rapidly cooling economy. Given that China’s stupendous growth rate in the past decade has been the result of an investment boom to produce goods for export, it is hardly surprising that the economy is in trouble.
Nor is it surprising that Beijing is doing its utmost to reverse the trend.
Chinese Prime Minister Wen Jiabao (溫家寶) was recently reported as saying that without high levels of growth, “factors damaging social stability will grow.”
The government’s real fear is of 100,000 unemployed graduates taking to the streets during the course of this year, demanding political and economic reform.
Fearful of stirring up protectionist pressure in the US, Beijing has so far eschewed the obvious policy response — a devaluation to make Chinese exports cheaper. But it is spending prodigiously on subsidies to prevent investment programs from being mothballed.
As the statistics show, world output of steel has fallen by a quarter since the middle of last year, but the adjustment is concentrated outside China.
“Nothing,” said Charles Dumas, of Lombard Street Research, “could be more emblematic of the distortion of China’s grossly excessive emphasis on exports and capital expenditure than its modest cuts to date in steel output.”
Resistance to such cuts becomes a lot more explicable if the ruling communist party believes economic slowdown will trigger unrest on a scale not seen since the crackdown in Tiananmen Square in 1989.
And if backed far enough into a corner, that could well mean devaluation. Beijing has a history in this area. It devalued by 33 percent in 1993, helping to lay the foundations for the subsequent export boom.
In the US, this would be seen as an economic Pearl Harbor and it would prompt swift retaliation in the form of tariffs on Chinese goods. Beijing knows that, and throughout the crisis so far has tried to play the part of a model global citizen. It would use devaluation only as a last resort.
Throughout the crisis, policymakers have comforted themselves with the thought that whatever difficulties they face, at least there is no prospect of a 1930s-style trade war.
But faced with the choice between political survival and upsetting the new president, Beijing will plump for the latter.
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