INSIGHT: Fed chairman sounds fire alarm for a new recession

19 July 2012 17:02  [Source: ICIS news]

Bernanke raises fire alarm for a new recessionBy Joe Kamalick

WASHINGTON (ICIS)--Federal Reserve Board Chairman Ben Bernanke this week warned Congress that the US economy will tumble into a new recession in early 2013 unless the legislature moves quickly to forestall looming tax increases and automatic federal budget cuts.

In delivering his regular semi-annual economic outlook to the Senate Banking Committee on Tuesday, Bernanke also raised alarm about the decelerating US economy and ever increasing risks that threaten an already weak and wobbly recovery.

For the chief of the US central bank to openly predict, practically guarantee a new recession in six months is fairly astounding.

Like Fed chairmen before him, Bernanke usually speaks in carefully obscure, cryptic and confusing terms precisely designed to avoid clarity. This linguistic tactic even has a name, “Fedspeak”.

Fedspeak is purposely crafted to avoid triggering major market moves in either direction because of what the Fed chairman might happen to say in any public venue.

So for Bernanke to baldly predict a new recession beginning in six months is the Fedspeak equivalent of shouting “Fire!” in a crowded theatre.

Bernanke uttered his rhetorical scream because in this election year, with Congress deadlocked on financial and most other policy issues, the Fed chairman and many others fear that the nation’s political leaders will fail to act in time – even as smoke billows into the political theatre and fiscal flames flicker amid the economy’s foundations.  

The fire alarms are plentiful, Bernanke told Congress, noting that US economic activity slowed still further in the first half of this year, and second quarter GDP growth is likely to be even less than the anaemic 1.9% expansion reported for the first quarter.

US jobs growth slowed significantly in the second quarter and is not likely to improve anytime soon, he said.

The US unemployment rate rose slightly in May to 8.2% after trending down in the fourth quarter last year and the first few months of this year. That rate held steady in the June jobless report.

“Given that [GDP] growth is projected to be not much above the rate needed to absorb new entrants to the labour force,” Bernanke said, Fed economists “now have the unemployment rate at 7% or higher through the end of 2014.”

Bernanke cited the three-month slowdown in consumer spending, saying that “households remain concerned about their employment and income prospects and their overall level of confidence remains relatively low”.

In addition, he noted that the US manufacturing sector has begun to contract – the first negative growth in production since the end of the 2008-2009 recession – and business spending on equipment also has decelerated since the first quarter, with further weakness in business investment likely to come.

While the long-depressed housing sector has seen some modest signs of improvement, Bernanke said, the crucial home-building industry still faces headwinds posed by worried would-be buyers, still tight lending terms and the ongoing inflow of foreclosed properties that continues to divert demand from new construction.

Last and perhaps most importantly, the Fed chairman warned that unless Congress takes prompt action to avoid them, major income tax increases and mandated federal spending cuts scheduled for the end of this year will push the US economy over a “fiscal cliff”.

That fiscal cliff awaits at the end of December this year and on the first day of 2013 when Bush-era tax cuts expire – meaning US household tax bills will increase by $221bn (€181bn) next year – and other expiring tax cuts and mandatory federal spending reductions will suck another $400bn out of the nation’s economy.

“If the full range of tax increases and spending cuts were allowed to take effect,” Bernanke told Congress, “a shallow recession would occur early next year.”

That Damoclean sword has already begun to slice away at US consumer spending and business investment as households and CEOs are chilled by those looming costs and husband their resources.

In addition to the rash of negative domestic developments slowing the US recovery, Bernanke warned that Europe’s ongoing financial travails could further entangle the US economy.

“Fiscal strains associated with the crisis in Europe have increased since earlier in the year, which – as I already noted – are weighing on both global and domestic economic activity,” he said.

The ongoing EU financial crisis has broadly affected US export sales, which have been one of the few bright spots of the US economy.

Despite recent efforts by European leaders and EU institutions to contain the eurozone sovereign debt epidemic, Bernanke said that “Europe’s financial markets and economy remain under significant stress, with spill-over effects on financial and economic conditions in the rest of the world, including the US”.

“Moreover, the possibility that the situation in Europe will worsen further remains a significant risk to the outlook,” he said.

Even as Bernanke’s dire warnings echoed in the halls of Congress, the International Monetary Fund (IMF) warned on Wednesday that the European sovereign debt and financial crisis has reached “a new and critical stage” and that the euro currency union is at risk of collapse.

In its new 50-page review of the status of the economic and monetary union (EMU) of the eurozone nations, the IMF cautioned that “despite major policy actions, financial markets in parts of the region remain under acute stress, raising questions about the viability of the monetary union itself”.

The IMF was referring to the June meeting of eurozone leaders and finance ministers in which a €100bn ($123bn) fund was agreed to support Spain’s wobbly banking sector.

The financial summit also agreed to ease economic reform demands on Madrid, and in return the Spanish government announced new taxes and spending cuts.

But many analysts think those measures – and other steps taken to shore-up the failing economies of Greece, Portugal and Ireland – may not be sufficient to stop the eurozone slide toward collapse.

Wednesday’s report by the IMF appeared to mirror those concerns, noting that “financial markets are increasingly fragmenting along national borders, demand is weakening ... and unemployment is increasing”.

To resolve the crisis and avoid collapse of the EMU and the euro, the IMF said that “a determined move toward a more complete union is needed now”.

“To this end, the first priority is a banking union for the euro area, with a common supervisory and macroprudential framework, deposit guarantee scheme, and bank resolution authority,” the recommendation says.

The banking union, said IMF, “needs to be complemented by more fiscal integration – combining ideas of a political union and stronger central governance with more risk sharing”.

But such a more powerful central European government and financial risk-sharing is broadly opposed by Germany, and other European governments are leery of giving up the significant share of national sovereignty that would be required for a eurozone fiscal union with real authority and control over member nations’ budgets, financing and banking. 

And, even without German opposition, analysts say that getting the 17 eurozone nations and their legislatures to agree on detailed terms of a banking union and “a stronger central governance” could take many months, perhaps years – a luxury of time that the deepening crisis likely will not allow.

($1 = €0.82)

Paul Hodges studies key influences shaping the chemical industry in Chemicals and the Economy

By: Joe Kamalick
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