Where is the US economy headed?

The Bank for International Settlements in Switzerland has just published its annual report, and it is a dour document. The BIS (as it’s known) was created in 1930 to handle post-World War I reparation payments from Germany to Britain and France. The Great Depression ended reparations, and now the BIS provides — among other things — sober commentary on the global economy. Its latest report oozes foreboding.

Consider:

debt: “The market turbulence surrounding the fiscal crises in Greece, Ireland and Portugal would pale beside the devastation that would follow a loss of investor confidence in the sovereign debt of a major economy.”

l On the need for higher interest rates: “Our attempts to cushion the blow from the last crisis must not sow the seeds of the next one.”

l On inflation: “Inflation risks have been driven up by . . . dwindling economic slack and increases in the prices of food, energy and other commodities.”
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On paper, there are answers. Governments could commit to future deficit reductions without weakening the recovery if their measures are “credible.” This is easier said than done. Or the expanding “new world” — China, India, Brazil — could rescue the old. Maybe. But these countries also have the highest inflation: almost 6 percent in China, 9 percent in India. Or today’s slowdown could prove temporary; private demand could revive.

The present need to sustain recovery seems to collide with future needs to curb debt. Our public debate is confusing and our policy paralyzed because no one — most obviously, Obama — has disarmed the contradiction.

How well has QE2 worked in achieving those goals? Let’s look:

“Higher stock prices” From the time of Mr. Bernanke’s op-ed to the middle of January, the S&P 500 rallied by just over 8 per cent. It has not done a thing since. Grade: One big fat B.

“Consumer wealth” Yes, the “equity wealth effect” did boost net worth by $2.4-trillion (U.S.) in the fourth quarter of 2010, but this slowed to just $943-billion in the first quarter (at an annual rate). Mr. Bernanke made no mention that much of this equity “wealth” would be offset by large declines in real estate asset values — a $226-billion decline in the fourth quarter and an even larger $338-billion contraction in the first three months of 2011. Grade: B-.

“Increase confidence” Uh oh. The Conference Board confidence measure did surge from 49.9 at the onset of QE2 to 72.0 in February, but since then it has declined to 60.8, reversing half of the initial burst. If sustainability is the key, then it is tough to give this a very good grade. Nice job in the first half, but a lousy second semester. Grade: C-.

“Spur spending” The six-month trend in real consumer spending was running at a 3.2-per-cent annual rate at the time QE2 was launched last November. That pace is now 2 per cent. On this basis, it doesn’t look as if QE2 made the grade. Grade: D-.

“Higher incomes” The six-month trend in real personal disposable income was rising at a tepid 0.8-per-cent annual rate at the time of QE2; it is now an even more tepid 0.6 per cent. To the back of the class, QE2! Grade: F.

“And profits” In the quarter just prior to QE2, U.S. corporate profits were rising at a 34.8-per-cent pace, year over year. The trend has moderated to 16.1 per cent in the fourth quarter and stood at 7.8 per cent in the last quarter. Grade: C-.

“Support economic expansion” What can you say about a meagre 1.8-per-cent GDP growth rate in the first quarter and little better than 2 per cent for the second quarter? Grade: D-.

Mr. Bernanke gave himself his own report card earlier this month when he came right out and declared that “until we see a sustained period of stronger job creation, we cannot consider the recovery to be truly established.”
This admission after 30 months of zero policy rates and 27 months of unprecedented expansion in the central bank balance sheet is startling and disquieting.
Indeed, during this fragile two-year-old recovery, despite all the stimulus, there has not been one quarter – not one – in which GDP growth performed better than the historical norm.

I’ll be generous and give QE2 an overall grade of D.