The Hindu Business Line : Fed out, Govt in again?

Continuing job losses, depressed house prices, rising foreclosures, possibility of a crash in commercial real estate — the bad news is not ending for America. Not a happy backdrop for the bimonthly meeting of the Federal Open Market Committee (FOMC) to decide US interest rates.

True, Q3 GDP grew 3.5 per cent (annualised), suggesting the economy is now out of recession. But the market thinks it’s a singular figure and is gloomy about prospects. That was reflected in the nearly 250-point fall of the Dow the very day after the release of the GDP data.

The Fed’s survey of the economy ahead of the FOMC meeting – the ‘Beige Book’ – found employment trends are still weak and improvement in economic conditions ‘scattered and modest’ at best. It’s too early to call any recovery. Luckily, there were no indications of inflationary pressures either.

These about sum up the case for keeping Fed rates where they are — near zero. So the talk around the FOMC table is hardly likely to be about any rate action.

What’s been the payoff for the huge injection of funds and guarantees for America’s biggest financial institutions? The US Treasury Secretary, Mr Timothy Geithner, says they’ve become ‘dramatically more stable’. He was one of the architects of the banks’ rescue package at the height of the crisis. But he is having a hard time defending their performance since. The latest results of the largest banks show old bad habits — disproportionate trading and risk taking in financial markets are back with a vengeance.

Mr Geithner laments that banks have given lending the go-by. Their performance is so bad that, at a time of recession, lending has actually contracted, even as their trading portfolios and positions increased.

The Fed seems to have run out of rope. The best it can do is to continue its ‘quantitative easing’, involving outright Treasury bond buying and financing illiquid paper.

The wheel’s come full circle and the scene could, therefore, once again shift to the fiscal side. Estimates are that about one-half of the Obama stimulus package of $787 billion is still unspent. There seems little doubt that with monetary ammunition running out, the onus will once again be back on Government.

The silver linings for the US economy are that China and India are recovering strongly and the weak dollar is export-stimulative. Besides, after years of living beyond his means, the average American is starting to run down his debt and save.

These may be just the right long-term prescriptions for a more stable economy and financial system and a lasting solution to global imbalances.

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