Faced With Spectre Of 1974, Fed May Make Radical Cut

The Fed may cut more than expected. Wall St. is hoping for half a point, but three-quarters may be more likely

Some economists would make the argument that the recession the world economy is entering now will be worse that the one in 1974. The recent record low in consumer confidence, huge job cuts throughout the economy, falling earnings forecasts, and a banking crisis which has no real precedent could haul GDP growth down for two years or longer.

But, 1974 was bad enough. Experts might settle for the same sort of downturn, but its brutality is hard to forget. GDP dropped six quarters in a row. Unemployment reached close to 9% and in some of the industrial sections of the US that figure was well in excess of 10%.

What Fed Chairman Ben Bernanke is facing is the awful world he already knows along with a world which he probably can predict will be much worse. Jobs are being lost so fast unemployment could rise from 6.1% in September to 8% at the end of this year or early in 2009. With housing prices still falling at 15% to 20% compared with 2007, there is no buffer at all for the consumer, especially if the he loses his job. His lack of access to credit is both historic and remarkable.

The nation’s businesses also have no access to cash. Coupled with falling sales from an economic slowdown, bankruptcies are likely to rocket up, not just at big firms like GM (GM), but at tens of thousands of smaller business. Companies with under 100 employees still represent most of the jobs in the US economy. These operations have even less access to capital than larger corporations which may be able to pledge huge asset bases or turn to the public credit markets.

Bernanke should appropriately fear the fact that the banking crisis could get worse again. The $700 billion that the US government has to bailout banks is now being considered as a source of funds for municipalities and corporations. Local government pension and health plans are underfunded. Workers may be forced to face loss of health care or retirement benefits if the federal government cannot step in. At the same time a falling economy and worsening housing market may well put more pressure on bank earnings and reserves. The desire to lend money may actually get worse, if that is possible.

While insolvency of banks, businesses, and the average citizen may be the most immediate threat to the economy, Bernanke can count on OPEC to cut crude production until oil moves back toward $100. At some point, the cartel can make certain that falling demand is met with an even sharper drop in supply Nations like Venezuela and Iran face the same global slowdown that the US does. Their only access to capital is through oil profits.

As Bernanke looks into the early part of next year, it should not be hard for him to imagine a jobless rate which moves over 10% and quarterly GDP drops of 3% or 4%. He has one last chance to slow the economy’s momentum in that direction.

Bernanke is out of time.

Douglas A. McIntyre