In today's FT, from Philip Verleger of the Institute for International Economics, Fred Bergstein's think tank:
US suffers as Bush's gamble fails
After his 1964 landslide election, President Lyndon Johnson gambled that the US economy could support a war and his Great Society programme. He lost. The expenditures exceeded economic capacity. Shortages occurred, prices rose, and a 15-year inflationary spiral began. Within two years, the Federal Reserve had to intervene by raising interest rates. Economic growth stopped and harsh economic conditions brought an end to Johnson's dreams.
Forty years later, another president from Texas made another wager: betting the US could fight a war, reduce taxes and avoid conserving energy. He also lost. Over the next two years, President George W. Bush will see inflation return and the Federal Reserve Board act to offset his profligate energy and fiscal policies.
President Bush (...) and his advisers also gambled, although in a different game. Johnson tried to provide guns and butter without raising taxes. George Bush tried to serve up large tax cuts without reducing spending or addressing the nation's rapacious thirst for motor fuels, particularly gasoline.
The loss of natural gas supplies adds to inflationary pressures. Katrina and Rita destroyed perhaps 5 per cent of the nation's natural gas supply, causing large price increases. Heating bills could double this winter. Furthermore, the cost of goods manufactured using natural gas, such as PVC pipe, will climb sharply even before rebuilding efforts boost demand.
[gasoline and diesel] price hikes could have been avoided had we pursued a programme to limit increases in motor fuel consumption. Here, too, George Bush made a bet. Efforts to tighten fuel economy standards for new vehicles were rejected when his energy programme was introduced and Congress refused to change it. The president declined to push a gasoline tax following 9/11. He wagered that an already stretched refining industry could meet mounting gasoline demand, which is largely linked to American affinity for large SUVs and trucks. (...) Although the calculations are hard to believe, econometric models suggest retail gasoline prices might need to double by next summer to maintain market balance.
There is only one end to this scenario: higher interest rates. A vigilant Federal Reserve Board will have to boost rates to suppress demand, just as during the Johnson administration. The pressure for higher rates will be even greater given the forthcoming retirement of Alan Greenspan as Fed chairman. His replacement will need to convince financial markets that the Board remains determined to keep inflation in check. The consequences will be a slowdown or worse.
As the rebuilding effort slows, high interest rates and high gasoline prices may pull the economy into recession. Like President Johnson, President Bush took a chance and lost.
I find this article interesting for a number of reasons:
- its publication shows the FT's continued bearish outlook on the world economy and their strong awareness of the acute energy crisis we are entering. Their front page today is again about oil (this time about the worries expressed at the IMF summit) and they have published a steady drum of stories about energy getting scarcer or more expensive, as my readers know well from my regular quotes. That means that the business community in Europe is becoming increasingly aware that this is a major issue;
- the linkage between the budgetary policy and the energy policy is a vital one. Bush has refused to address the energy issue and has tried instead to drown it instead, with Greenspan's help, in a massive monetary and budgetary spending binge. We'll pay "whatever it takes" to get our energy without limits is his (and America's) motto. Well, that binge may come to an end, and Katrina may have been the wall that stopped Bush's unsustainable policies, as it shows that there is no spare capacity in the refining sector (to fuel America's wasteful cars), in the construction sector (to rebuild what was destroyed), and in the global financial world (to finance it all on Uncle Sam's plastic);
- the insight that price rises will need to be massive to have an effect on America's insatiable demand. A lot of Americans will change only when in financial pain; big changes will require a lot of pain;
- the important note that natural gas is the biggest short term problem. I have promised to write more about this, and I will, but note again that this will lead to higher heating and higher electricity prices - higher meaning probably double their current levels;
- the conclusion is that the only outcome is higher interest rates. Greenspan leaving is a good thing, but his God-like status does mean that his replacement will need to establish his/her credibility - and that will mean a hawkish attitude on inflation. That's what's needed, but it will happen faster than most expect, and it will be painful - in all likelihood popping the housing bubble and increasing debt servicing costs for most.
In a way, it is ironic that Iraq will end the same way that Vietnam did - because the USA could not afford it anymore. But at least Johnson was trying to build the Great Society at the same time. Bush has only been trying to shovel money to his rich cronies. History will not be kind to him.