The Economy

On paper, the economy looks fairly good. Inflation is low, unemployment is high but falling, and the economy is expected to resume growth later this year. When you look closer, things are not as rosy.

The official measure for inflation is rather strange and designed to understate the real inflation rate. It ignores energy prices so $4+/gallon is not reflected. It also gives a large weight to housing prices. Currently gas, food, and clothing prices are rising but this is either ignored or minimized by stagnant home values.

Unemployment figures are based on the number of unemployed people looking for work. If you give up and stop looking the unemployment figure drops. If you are underemployed meaning that you have a part-time or low-wage job you are not counted, either.

The economy is expected to return to 3% growth later this year. That is not enough to make much of a dent in the unemployment figures. Worse, economic growth figures depend on accurate figures on inflation. If inflation is understated then economic growth is overstated.

Some of these problems are global, especially oil and food prices. Domestic policy has caused other problems. Both the Bush and Obama administrations have supported a weak dollar. The idea is to make American exports cheaper in order to strengthen manufacturing while making imports more expensive. This has not been particularly successful. Probably one reason is that a weak dollar adds to the price of imported raw materials. It also depresses commerce based on resale of imported goods.

One way that the dollar was kept low was to keep interest rates low. This also fed home sales and second mortgages, causing the housing bubble. Millions of people took out variable-rate loans. When rising gas prices in 2008 triggered price increases, the Fed raised interest rates, pushing those variable rates above what many people could pay. This had repercussions throughout the economy.

Because interest rates had been so low for so long, the Fed had very little to work with to boost the economy. They did what they could, lowering interest rates to near-zero and buying back bonds. Neither had much effect and both weaken the dollar further, threatening future inflation.

The Bush administration tried a stimulus by sending out tax rebate checks. This was insufficient. The Obama tried a much larger stimulus but it was poorly designed. Around a third went to weekly tax cuts which were too small to actually affect spending. These expired recently, anyway. Another third went to bailing out state and local governments. This did not stimulate the economy. The most that can be said for it is that it postponed further cuts at the state and local level. That money is also gone which is why the nearly all the states are facing a budget shortfall now instead of two years ago. The rest of the stimulus went for pork barrel projects that made no attempt to match spending and unemployment. The result of all of this is a massive deficit with nothing to show for all of the spending. To quote Henry Morgenthau Jr., FDR's Secretary of the Treasury, "We have tried spending money. We are spending more than we have ever spent before and it does not work."

We seem to be headed for stagflation, the scourge of the 1970s. This is a stagnant economy coupled with high inflation. The effects of high unemployment on an economy have been visible for the last couple of years. Even people who are employed are cautious about spending because they don't know if their jobs will last. Inflation is worse. You can see inflation at work at the gas pump. Every time you go to fill your tank the prices are higher. It affects your plans. Imagine seeing this happen on everything, especially food.

The future does not look bright. Housing prices have not recovered and may still be dropping in some markets. Rising gas prices will hit vacation areas. Eventually the Fed will have to choose between stimulating the economy and controlling inflation. The economy could be headed for another recession.

There are some things that the government could do. A commitment to domestic oil and gas would stop long-term speculation and would stimulate energy-related jobs in the Gulf states. Ending subsidies and mandates on corn ethanol would directly lower the price of corn and indirectly the price of meat, eggs, and dairy. The first would be generally popular but would alienate President Obama's base. The second would alienate Iowa farmers and is politically impossible until after the caucuses and possibly the election.

In the meantime it's going to be a tough year or two.