My turn: A Juneau economist ponders the 'R' word

Posted: Sunday, March 23, 2008

I usually agree with columnist Gregg Erickson on economic issues, but I was truly hoping Gregg was wrong about the R word - recession.

My skepticism stems from the good news still present. Inflation is still at bay. Consumer spending is still growing. Unemployment is rising, but is far from recession levels and a weaker dollar is making U.S. exports more competitive.

But my real concern is that federal policies are nibbling around the wrong edges and may even create even a bigger problem - a prolonged weaker U.S. dollar.

So why is the falling dollar so important? The strength of the dollar measures how the world views our economic vitality. The credit crunch coupled with an unsteady stock market is making our economy less attractive and has resulted in a weaker dollar. This means our dollar has less buying power when we purchase imports. And, while it also means that our exports are more competitive in foreign markets, we must remember we import far more than we export.

In addition to the weak dollar, there is the one-two punch of high energy costs and record-high consumer debt. These two factors also contribute to a weaker dollar and could push our economy over the edge. Nonetheless, our federal policies are not going here. Rather, the federal stimulus is aimed at spending our way out of our economic slowdown.

The Fed is aggressively cutting interest rates and making federally secured loans to the embattled investment banks. Unfortunately, the Fed's most effective weapon is money supply. In simple terms, the Fed makes more or less money available to banks, so that they can make loans to us. More money generally means lower interest rates and easier credit. Less Fed money means just the opposite.

The degree to which money is available to loan is called liquidity. But the liquidity problem we face today is not due to the Fed's money supply. It is a loss in investor and lender confidence in the world of finance. This is because they cannot identify the real risks of the bonds, insurance and other products they buy and sell to each other. This uncertainty has come about after an era of lax federal oversight. Simply stated, the captains of finance do not know whether they are throwing good money after bad. And, just offering lower interest rates is a secondary consideration at best.

In fact, the loss of investor confidence is so great it has resulted in a classic run on the bank. Bear Stearns was an investment bank that was already in big trouble over subprime mortgages. A federally secured loan was made to Bear Stearns, but investors interpreted this loan as further souring of the credit crisis rather than a bailout. Within 24 hours, Bear Sterns lost $5.7 billion and only had enough cash to keep the doors open for a day or two.

J.P. Morgan and the Fed prevented a disaster by making a bridge loan to Bear Stearns, but it was not enough and the bank was sold at fire sale prices. So the federal policy not only failed to stop the bleeding from the subprime debacle, but further resulted in a Depression-era run on a bank. Where is the economic stimulus here?

Another flaw in the stimulus package is that it is aimed at Main Street - the consumer. Consumer spending is our main economic engine and accounts for about 65 percent of our economy. Unfortunately, consumer debt is at an all-time high. Many home owners have already taken out their home equity by refinancing their mortgages. Moreover, credit card debt is at record levels. So the potential to stimulate the economy here is relatively low. Rather than spending their stimulus check on consumer goods, the average consumers will likely save it, or pay down debt. Not a bad idea.

Lastly, consumer spending will be offset by high energy costs and the weaker dollar. Energy is a must-have, and rising energy costs will eventually come at the expense of our discretionary spending. We use discretionary income to buy the-nice-to-have stuff. But a weakening dollar means our imported goods will become more expensive - especially the energy we import. So the "stimulus" is caught in a triple pinch. A weaker dollar increases energy costs and eats up discretionary income, and the weaker dollar also drives up the cost of imported consumer goods. So rather than policies that address expensive energy and the value of the dollar, we are getting a shovel to dig deeper.

So, what does the R word mean for Alaska? Well, that's for my next column - assuming they let me continue and Gregg Erickson is not wrong. I can tell you there are some real bright spots and challenges.

• Joe Mehrkens is a resident of Juneau.

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