Desperate times call for zero rates from Fed

From The TimesDecember 2, 2008

Desperate times call for zero rates from Fed
Gerard Baker: American view
It did not take long for a brief moment of hope on the US economic front to turn to ashes yesterday.

The weekend marked the beginning of the Christmas shopping season, with last Friday, the day after Thanksgiving, the busiest shopping day of the year.

Even a recession, it seems, cannot diminish the frenzy of the American consumer and Black Friday, as it is known, demonstrated, with frightening new ferocity, that the most dangerous place on earth is between an American and a bargain. A Wal-Mart employee at a New York store was trampled to death in the stampede, left unattended for crucial moments as shoppers got on with their business.

Leaving aside the death toll of one, early data from the weekend were mildly encouraging. Surprisingly, total sales seemed to be somewhat higher than they were a year ago, before recession hit. Spending at the big stores was up 3 per cent on a year earlier, according to ShopperTrak RCT, a research company that monitors such things, and a quick survey by the National Retail Federation found that American consumers spent an average of $372 per person on Friday, up 7per cent on a year ago.

Given that consumer spending seems to be in decline for the first time in at least 18 years, any positive signs from the shopping malls should be welcomed. The big retailers expressed cautious relief at the news, but they and analysts noted that the seasonal shopping spree doesn't always end as it begins - and most economists are still expecting slower sales between now and Christmas.

In any case, even the restrained economic joy was shortlived, overwhelmed by much more troubling news yesterday. On the first of each month the Institute for Supply Management (ISM) publishes its survey of manufacturing activity in the previous month; the report is always keenly watched as the most up-to-date reliable information about the state of the economy.

Yesterday's report for November was the grimmest in a generation.

The headline purchasing managers' index hit its lowest level since 1982. That news came on the same day that the body that “officially” determines the beginning and end of US business cycles confirmed that the economy had entered a recession at the end of 2007. The call by the National Bureau of Economic Research means that the current recession - assuming, as seems safe, that it is still going on - is already longer than both the last two short, shallow downturns of 1991 and 2001.

The ISM report put new orders and production at their lowest levels since 1980. Export orders - the one bright spot for the US economy for most of this year - were at their lowest in 20 years. The world economy is deteriorating at an even faster pace than that of the United States, as evidenced by purchasing managers' indices in Europe yesterday. That, and the sharp appreciation of the dollar in the past few months, means that the global picture is now adding to, rather than abating, the misery for US manufacturers.

A separate report yesterday showed another sharp decline in construction spending in October. All in all, the numbers suggest that the slight decline in gross domestic product recorded in the third quarter of 2008 will be followed by a much more severe downturn in the fourth quarter. The data seem to be getting worse all the time, meaning that the present, mildly optimistic official forecasts for 2009 are looking increasingly vulnerable to a downwards revision.

Most worrying of all, perhaps, is the gathering evidence of deflation. The purchasing managers' index showed that the index for prices paid by manufacturers for raw materials and semi-finished goods fell to its lowest level in more than 50 years. This, of course, reflects the dramatic drop in energy and other commodity prices in the past six months.

Prices are simply crashing now in the US and around much of the world. That must surely, at least in part, explain the unexpectedly strong performance of retail sales at the weekend. Those low prices attracted shoppers in enough numbers to lift not only the volume of sales but also the total value: that strongly suggests that, with petrol prices now less than half what they were a few months ago, Americans have a little more spending power in their pocket.

The big question is how deeply embedded in general prices this deflation becomes. Just as the increases in oil and commodity prices over the past couple of years did not have to equate to general inflation (and didn't, in fact) so declines in those major components do not have to mean sustained falls in prices - with the corrosive effects on consumption and investment that situation implies.

But consumer and market expectations for price are now plummeting, posing a real risk that those declines will become embedded and begin affecting consumer behaviour.

All this means that the policy response needs to be even more aggressive than envisaged. Expect the Federal Reserve to emulate the Bank of Japan in the 1990s and cut short-term interest rates to zero and to begin pumping even more cash into the economy in a desperate attempt to halt the slide in prices and economic activity. Japan had a lost decade of economic growth as financial and economic storms raged. The US is now in a real struggle to avoid something similar.