Commentary August 25, 2010, 11:01PM EST

Interest Rates: The Zero Percent Solution

(page 2 of 2)

U.S. economic performance continues to disappoint. New-home sales collapsed by 12 percent in July to an annual pace of 276,000, the lowest level since the Commerce Dept. began compiling figures in 1964, and the median price of $204,000 is the cheapest since late 2003. Orders for durable goods rose just 0.3 percent, compared with the 3 percent gain predicted by economists. Against that backdrop, it's hard to see how anyone can get worried that higher rates are needed anytime soon to restrain inflation.

Those who oppose watering down the various stimulus packages that are keeping the economy alive see warning signs everywhere. Europe is looking anxiously to the East, concerned that China will be too successful at reining in growth. Olli Rehn, the European Union's economic chief, says that slowing Asian economies would have a "serious negative impact" on his region. The U.S., meantime, frets that Europe will slide back into recession, making the dreaded double-dip a reality. "Cutting back willy-nilly on high-return investments just to make the picture of the deficit look better is really foolish," Nobel prize-winning economist Joseph Stiglitz told Dublin-based RTE Radio in an interview broadcast on Aug. 24. And almost every supporter of doing more, not less, to resuscitate animal spirits is looking to the recent history of Japan as the chief reason why austerity should not be the new black. "What we're doing is setting ourselves up for a longer-term Japanese-style malaise of weak growth for an extended period of time," Stiglitz says.

Austerity Push in the U.K.

Even Axel Weber, typically a hawk among hawks at his Bundesbank roost in Frankfurt, says the European Central Bank should do nothing to slow the pace of liquidity keeping the economy afloat until at least the first quarter of next year. "The health of the financial system and the banking system" will dictate whether the recovery is sufficiently robust to withstand the withdrawal of central bank support, he said earlier this month.

It's the U.K. that is setting the pace on heading for the exit. Prime Minister David Cameron has embraced austerity and spending cuts in an effort to safeguard Britain's AAA credit rating and avoid the fate of Greece, whose surging deficit has made it a pariah in international capital markets. If Cameron can persuade Parliament to back his efforts to slash the U.K. debt burden, and succeeds in shrinking government payrolls without sabotaging the recovery, U.S. lawmakers keen to scale back government intervention might take heart.

Paul McCulley at Pimco, which runs the world's biggest bond fund, reckons it might take a stock-market slump to dissuade U.S. politicians from risking recession by embracing austerity. He's not forecasting collapse, though he thinks the risk is rising.

"Surreally, Congress is presently wrapped around the austerity axle," McCulley says. "I happen to think this is bad policy, very bad policy. That could change if the risk of a return to recession continues to rise, spooking the equity market. A few thousand points of Dow might be what is needed to get the attention of austerian legislators wanting to get reelected."

Gilbert is the London bureau chief and a columnist for Bloomberg News. With Scott Lanman in Washington D.C., Matthew Brown and Simon Kennedy in London, and Vivien Lou Chen in San Francisco.

Reader Discussion

 

BW Mall - Sponsored Links

Buy a link now!