Obama's plan fixes nothing

Last week, stocks prices fell more than 5 per cent because of specific economic events and policy responses from Congress and President Obama.

Stocks may recover, but recent events demonstrate how nervous investors are becoming about what they see in primary economic indicators, and the President's populist and ill-directed responses.

Since January 1, signs that the economic recovery may be faltering have emerged – jobs losses and new unemployment claims are up again and remain at recession levels; retail sales appear to be struggling; housing prices show signs of falling again; and demand for new homes is declining (fewer visits to new home showrooms and disappointing sales data); and non- residential construction and jobs in that sector continue to fall.

China's fixed exchange rate policy has destabilised the US and Chinese economies, sending tremors around the globe.

In the United States, China's policy floods markets with products priced at less than their cost of production and throws Americans out of work without creating new jobs in export industries – falling employment results in poor retail sales and more job losses – what economists call the multiplier effect.

In China, the fixed exchange rate for the yuan against the dollar requires Beijing to print lots of yuan to sweep dollars off foreign exchange markets and return to China as payment for exports. This causes inflation, too easy credit and an asset bubble. Instead of fixing the problem by steady and significant revaluation of the yuan dollar peg, the Chinese government is pulling back on credit and that could cause a second crisis on both sides of the Pacific. A Chinese asset crash could be the next big thing, and that won't be a good thing.

US banks are paying out $150 billion in bonuses indicating that profits at healthy banks jumped more than the economy grew in the second half of 2009. A lot of that is paper growth – swapping money borrowed from the Fed at cheap rates for other securities – and only creates sales jobs mostly for realtors in the Hamptons, clerks at high purveyors of luxury goods in Manhattan and starched waiters at high end eateries.

Average compensation at the banks is 5 and 10 times the typical American, after bankers nearly threw the economy into a second Great Recession, and each week about 450,000 Americans apply for their first unemployment cheque .

All of these things scare investors and are driving the market down.


Ill-Conceived Policy Responses

In the wake of the public backlash that caused a political setback in Massachusetts for Democrats, the President is proposing ineffective solutions that scare investors further and push down the stock market as much as objective economic conditions.

Obama's tax on bank capital – $10 billion a year – would drive banks out of New York and offshore without correcting the dysfunctions in domestic lending practices, the sale of mortgages and other loans for conversion into securities, derivatives trading, and bank investments in dodgy residential and mortgage backed securities which caused the failure of many regional banks.

Obama's proposal to prohibit proprietary trading by banks on their own accounts would do nothing to reform these practices either. The crisis was caused by poorly considered loans, the packaging of those loans into opaque securities, and swaps written on those securities by non-bank entities, who would escape Obama's proposed cures. The president is playing populist politics with the banks, and investors see it and are frightened.

Now Democrats in Congress are threatening to dump Ben Bernanke, when in truth the banks and Obama are the problem. Neither will be subject to real constraints by Congress. The banks will continue trading and not lending, and Obama will continue pushing programs that divide a shrinking pie instead of focusing on growing the pie again.


Peter Morici is a professor at the Smith School of Business, University of Maryland School, and former Chief Economist at the US International Trade Commission.