June 19, 2024

High & Low Finance: Slower Growth, Higher Prices: Tight Spot for the Fed

It makes sense to think the pause in growth will be temporary. Part of the first-quarter slowdown was caused by a weakness in the growth rate of exports that should not endure as developing economies continue to expand. There was also severe weather, which if anything should accelerate second-quarter growth with catch-up spending. And military spending declined.

With all those things, the economy grew at a 1.8 percent annual rate, according to the first estimate released by the government on Thursday.

To make the case for a rebound even stronger, the commentary from companies reporting first-quarter earnings has generally been upbeat. They are continuing to see sales rise, and profits are looking good. They are more awash in cash than ever, and many of them say they plan to hire more American workers. The recent surprise in unemployment numbers has been in how rapidly they fell.

This week, even as the Fed was lowering its forecast for economic growth in 2011, it was also lowering its expectations for unemployment. It had no choice. Back in January the consensus among Fed officials was that the unemployment rate would be 8.8 to 9 percent in the final quarter of 2011. It has already fallen to 8.8 percent, and the new consensus, of 8.4 to 8.7 percent, could be far too pessimistic if companies mean what they say about hiring.

But there could be a sign of possible problems in, of all places, China.

China’s steel prices, which had been rising rapidly, started to slide in mid-February. They bounced back for a week after the earthquake and tsunami in Japan, but have slipped since then.

What does that mean? Maybe nothing. China’s steel market is a wondrous combination of socialism and capitalism. Chinese steel is mostly sold through markets where prices can bounce wildly, and traders seek to profit from volatility. There are few good statistics on such basic things as inventories, making markets nervous about any change in direction. The producers are mostly government-owned companies, often managed by local governments more interested in jobs than profits. (Can you imagine such a thing in a developed economy?)

So Chinese steel statistics must be approached with caution.

One interpretation of the slipping prices is that the pre-tsunami decline was just market noise, and that the decline since then represents a correct analysis that Japan will be importing a lot less steel as manufacturing is interrupted by parts shortages. There is talk that the Japanese economy will shrink at a rate of 5 to 8 percent in the second quarter.

A steel analyst I have trusted for many years, Michelle Applebaum, the managing partner of Steel Market Intelligence, an equity research firm, cautioned me against leaping to conclusions, but added that if the decline in Chinese prices continued, “then, of course, it would be indicative that their rate of growth is slowing.” China, she said, is “growing in a very steel-intensive way.”

That is a prospect that should make the world at least a little nervous. China grew at an annual rate of 9.7 percent in the first quarter, according to official statistics. Europe, meanwhile, seems determined to impose austerity and debt reduction at the same time the European Central Bank raises interest rates.

Think of China as the primary engine of world growth and Europe as a brake. The world may not grow much if that engine starts to stutter before the old primary engine — the United States — starts to rev up.

China’s government keeps vowing to do something to slow its inflation, and has been trying to discourage credit growth and reduce the volume of new construction projects. In the West, there has been general disbelief that it could possibly succeed. After all, by tying the renminbi to the dollar, China has effectively turned over its monetary policy to Mr. Bernanke and his colleagues, whose dual mandate of promoting American growth and fighting American inflation says nothing about stopping China from overheating.

China’s economy may well not be slowing. Perhaps the steel figures represent government efforts to hold down reported inflation by putting pressure on producers, à la President John F. Kennedy and United States Steel in 1962. But all good things come to an end, and someday China’s growth rate will slow. By then, the world may no longer need the help. But it does now.

The Fed has been doing everything it can to stimulate the American economy, but has been rewarded for its efforts with denunciations. Liberals gripe that it is not doing enough to bring down unemployment. Conservatives complain that it is encouraging inflation by printing money. To hear some of them tell it, Mr. Bernanke is a member of the Obama administration who is destroying the currency to help the president win re-election.

That is not how you would expect conservatives to view a man who used to be chairman of the Council of Economic Advisers under George W. Bush, but these days many Republicans view Mr. Bush as something of a heretic for raising government spending.

Monetary policy is clearly on hold now. Mr. Bernanke may or may not think it is a good idea to end the Fed’s purchases of longer-term Treasuries — the program known as QE2, for quantitative easing. But he had no choice, given the political realities.

The Fed is caught in a bind, with inflation rising and growth perhaps slowing. “A surge in commodity prices unavoidably impairs performance with respect to both aspects of the Federal Reserve’s dual mandate,” Janet L. Yellin, the Fed’s vice chairwoman, pointed out in her talk to the Economic Club of New York earlier this month. “Such shocks push up unemployment and raise inflation. A policy easing might alleviate the effects on employment but would tend to exacerbate the inflationary effects; conversely, policy firming might mitigate the rise in inflation but would contribute to an even weaker economic recovery.”

For much of the last two years, growth in federal government spending helped. But now, that spending is falling. And state and local government spending, adjusted for inflation, is at its lowest level in nine years.

The American outlook would be much worse if there really was much chance of a rapid reduction in government spending, as the politicians say they want. With the recovery stumbling, tighter monetary and fiscal policy could be disastrous. But it is probable that there will be no deal and that after a new episode of “The Perils of Pauline,” the debt ceiling will be raised and a temporary deal worked out that makes no one happy.

The risk is that if things do get worse, perhaps because that fall in Chinese steel prices really does mean something, the government will be impotent. Stalemate could keep fiscal policy in neutral or worse, and political pressures could prevent any monetary easing until it is far too late to prevent a new downturn.

Let’s hope that Mr. Bernanke is right to think both the slow growth rate of the first quarter and the rise in inflation are transitory phenomena.

Article source: http://feeds.nytimes.com/click.phdo?i=c44a1d7065f4279444ef96c923b8b5c2

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