Outside editorial: New kind of funk

Posted: Thursday, June 19, 2008

The latest economic headlines conjure up memories of Jimmy Carter in a sweater. Inflation is up. Gasoline prices are hitting records. The economy is sputtering. The ayatollahs are misbehaving. If you change the channel, you almost expect to see the Fonz.

For all of that, the American economy is not headed back to the disco days of the dreary 1970s. What the economy is going through today is a new kind of funk, unlike anything that's come before. And that has Americans worried.

Polls consistently show the economy to be the No. 1 issue on the minds of voters. The No. 2 issue: the price of gasoline. In the latest Hotline-Diageo Poll, concern about gasoline prices is rising faster than gas prices themselves. Today's rising gas prices are not a blip created by OPEC squeezing supplies, as it did in the 1970s; they are a new fact of life caused by growing international demand.

Something else that's unusual: Inflation is going up, even as American economic growth slows down. America is the world's biggest purchaser of nearly everything. When we slow our buying, that usually dampens inflation at home and around the world. That's not happening this time.

It suggests that Asia's rise is limiting America's ability to influence its own economic destiny.

Consider the dilemma facing the Federal Reserve: The standard medicine for a weakening economy is to cut interest rates; the Fed has cut rates by more than half in the last year. Those cuts have helped stave off the worst effects of recession.

But now the Fed's hands are tied by inflation worries. In America, slow growth has stopped inflation from spreading much beyond food and fuel. Prices have been rising at a 4.9 percent annual rate over the past three months. If you don't count the rising food and fuel prices, the annualized inflation rate is a more tolerable 1.8 percent.

This may not last. General inflation could break out quickly if the economy picks up and producers feel free to pass rising raw material prices along to consumers. So the Fed is sitting tight on interest rates for now, hinting that it might even raise them by fall. This tough talk is probably just that - talk. Raising interest rates, which generally increases unemployment, right before a presidential election would be politically risky.

All of this means that the U.S. economic slump may linger longer than it otherwise might.

As the U.S. economy has slowed, those of Europe and, especially, Asia have rolled merrily along, which also is something new. It used to be that when America sneezed, other nations caught a cold.

The nice part about the strong Asian and European economies is that they keep markets for U.S. exports strong, which, in turn, keeps Americans working. But it also pushes prices higher for oil and other commodities, especially when measured in our shrinking dollars.

Inflation is worrisome in America, but it's more worrisome elsewhere. Prices are up 8 percent in fast-growing China and India, and even higher in countries such as Turkey, Pakistan, Venezuela. Food riots are breaking out in poorer nations.

Asian governments are loath to slow their own economies in order to slay the inflation beast, in part because of the fear of social disorder. Raising interest rates also could raise the value of their currencies against the dollar, weakening their exports.

Trading inflation rates for growth is a devil's bargain, as America learned in the 1970s: Once inflation starts, it becomes very hard to stop.

That last happened here in the 1970s, and it took 11 percent unemployment during the severe recession of the early 1980s to finally tame prices. The Chinese should take note, although unemployment is less of a political problem in a country that doesn't hold elections.

The consequences of America's diminished world economic clout are unclear, but they won't be pleasant. Add to that the dislocation caused by higher food prices and $4-a-gallon (and rising) gasoline, and it's not surprising that Americans are a little nervous. This is new, uncharted territory.

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