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by Abid Aslam

War Spending Undermines U.S. Economy

(IPS) WASHINGTON -- The U.S. economy will slow down and face increased inflation pressure in coming months, but it will likely be spared the crippling stagflation that occurred in the 1970s, the central bank chief predicted Thursday.

Ben Bernanke, the Federal Reserve chairman, explained to the congressional Joint Economic Committee that the credit crunch, housing slump and market turmoil stemming from shaky U.S. home loans have proven more pronounced than anticipated and therefore portend sluggish economic performance into early 2008. At the same time, rocketing energy prices and a weak dollar have brought inflationary pressure to bear on the economy, he said.

The central bank's Federal Open Market Committee, which sets key interest rates, "expected that the growth of economic activity would slow noticeably in the fourth quarter," Bernanke said.

Growth should start to recover later next year but, added Bernanke, "the committee also saw downside risks to this projection" if the housing slump led to a significant fall in consumer spending.

He insisted, however, that the Fed had not taken an "alarmist" view regarding the likely impact of lower real estate prices on consumption.

Rather, the central bank saw an equal threat of inflation and therefore would be reluctant to ease the credit crunch further by making borrowing any cheaper, Bernanke added.

The Fed has cut the key interest rate for loans between banks twice in as many months to 4.5 percent, from 5.25 percent before September. It last took such an assertive action in 2001, when the economy began to claw its way back from the last recession.

The already weak U.S. dollar has fallen faster against other currencies since the Fed began cutting rates. Lower interest in the United States makes not only its currency but also dollar-denominated stocks and bonds less attractive to foreign investors.

The U.S. economy grew by 3.9 percent during the third quarter of this year, but the rate likely will slacken to 2 percent or less in the fourth quarter, the Fed projected. Senior Fed officials have been quoted in reports this week as saying that growth would have to fall to below 1.5 percent before the central bank lowered interest rates further.

Financial speculators, however, are betting that the economy will fare so poorly that the Fed will be forced to lop another quarter-point off its key rate by the end of the year before cutting it to 3.75 percent or 4 percent come late January.

Bill Gross, chief investment officer at Pimco, the world's top bond fund, told the CNBC news channel earlier in the week that the Fed could not afford to let U.S. housing prices fall sharply and would need to cut rates decisively, perhaps to 3.5 percent.

Bernanke kept his options open Thursday, saying the central bank "will respond as needed" based on economic data -- the latest of which, he told lawmakers, showed the economy "remained resilient."

His audience appeared unconvinced.

"I think we are at a moment of economic crisis," said Sen. Charles Schumer (D-New York). "I'm not surprised to hear experts, such as your predecessor Alan Greenspan, warn about the threat of a recession. I have begun to worry about it too."

Rep. Maurice Hinchey (D-New York), said the outlook reminded him of the stagflation -- a combination of stagnation and high inflation -- through which the U.S. economy suffered during the oil price shocks of the 1970s.

Bernanke emphasized that the Fed does not expect as dismal a situation to recur.

Even so, some commentators have begun using the term "slugflation" to describe what is coming: a sluggish economy gripped by inflation.

So far, the Fed's efforts to stabilize financial markets and buoy investor confidence have been dampened by an incoming tide of reports that major financial institutions have sustained heavy losses stemming from shaky mortgage loans and their subsequent repackaging and sale in the form of mortgage-backed securities.

Charles Prince III resigned as head of Citigroup Sunday amid revelations that the world's largest bank expected pre-tax losses of $8 billion to $11 billion on top of $6.5 billion written off three weeks earlier.

Last week, Merrill Lynch announced a write-off of $8.4 billion and sacked its chief executive, E. Stanley O'Neal.

How much loss the financial services industry has yet to disclose is the subject of wildly varying estimates. JP Morgan has been quoted as saying the sum could amount to $60 billion.

A number of top executives could yet lose their jobs and, at the other end of the economy, more than a million U.S. residents are believed to be at risk of losing their homes.

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Albion Monitor   November 8, 2007   (

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