A self-extinguishing recovery?

The economic news continues to yo-yo from optimism to pessimism—back and forth. Corporate profits are up but wages are down, mortgage defaults are decreasing in some areas and increasing in others, oil prices are above $100 a barrel, causing losses at airline companies; and analysts seem to feel that the economy is on a track to recovery, if a slow one.

But there are dangers that the recovery will short-circuit, for the same reasons that the economy tanked in 2008. Most of these problems have moderated due to the recession; but as soon as the economy starts to grow seriously, they will pop back up and send the nation back into a slump. I discuss these reasons – everything from concerns about inflation (driven primarily by rising energy prices) to low consumer spending and high debt to mortgage defaults – in Invisible Energy.

And I am concerned that these dangers have been largely brushed aside.

The only one discussed seriously in recent weeks is the deficit: Standard and Poor’s announced that it downgraded its outlook on the U.S. government’s debt from stable to negative.

But how would one fix the deficit? Current proposals by the Republicans would reduce government spending rapidly.  The Administration responded with proposals that also make cuts, although in much different ways. And with the stimulus money coming to an end, spending will drop in any event.

But lower spending means slower (or no) growth and fewer jobs. Spending cuts help solve one problem—deficits—at the same time that they worsen others—low consumer spending and jobs.

Shortsightedness: One particularly troublesome tradeoff that is being made is cutting high speed rail, as pointed out in the New York Times. I noted in my last blog, spending on high speed rail increases employment now and saves government spending on highways, parking, and airports in the long term. It addresses both problems—deficit reduction and job creation—in a good way. It also reduces oil use -- cutting oil prices and reducing the nation’s trade deficit. It also reduces the amount of money sent to adversaries of the United States such as Iran.

Short Memories: I am seeing similar problems in other areas. An ad on the radio this week talked about how listeners could qualify for a larger mortgage than they might expect. It seems that the lending industry thinks that it has gotten the problems of the last decade behind them, and is beginning to loosen up again.

But mortgage underwriting doesn’t figure in the costs of energy and transportation, and that’s where consumers get burned. These costs are typically almost $400,000 for a typical home in suburban sprawl. $400,000 is an obligation that is about 2 ½ times the amount the consumer pays for a loan on a median priced home! A burned consumer—one who can’t afford to pay his mortgage after paying for gas and car repairs and insurance and utilities—leads to a burned investor who bought the mortgage, in addition. This is what triggered the recession.

Gas prices are rising again to levels we haven’t seen in 3 years. At that time, we worried about gas prices, but after the recession reduced gas prices we never took the actions needed to save gas, and therefore reduce its price in the short- to mid- term. Expanding support for mass transit and other non-auto modes will offer consumers alternatives to $4-a gallon gas. This can be done by stopping transit service cuts in the short term and expanding transit, walking, and biking alternative in the medium term. But we are three years behind where we could be on this solution.

Downward Spiral of Oil Addiction: No one seems to address the issue of how the economy can continue to revive without sending oil prices through the roof. The scenario I worry about is consumers no longer being able to afford gas or heating oil or travel in general, causing  us to go right back into recession. High oil prices can hurt more than just consumer spending. They also hurt us by igniting inflation, which is already running over 2.5 percent for the past year.

And as oil prices cause inflation, the Federal Reserve will have no choice but to raise interest rates, and this will also send the economy back into decline. It will also exacerbate the government deficit.

Oil prices also increase our trade deficit, which weakens the dollar and drives up the cost of imports. The dollar is now worth less than 69 Euro cents, a level that is approaching its all time low of a few years ago.

The economy can’t really recover without oil prices staying in check. But the economy also can’t really recover without CAUSING oil prices to rise. This is what I mean by a self-extinguishing recovery.

A Better Way: The only plan I can see for addressing the root causes of the recession and allowing a robust and sustained recovery is to push aggressively forward on energy efficiency policies: notably and importantly in mortgage lending reform. Lending reform would empower new home construction in Smart Growth locations where the market is now demanding it,  and will also allow consumers to finance energy makeovers of their homes and businesses that can reduce utility bills by 30 to 50 percent and more. (Over a million and half barrels of oil a day are used in buildings.) Energy improvements in existing homes and businesses could also be incentivized through temporary tax credits or grants programs based on how much energy they save.

Better energy policies would also cut costs to consumers and businesses through raising minimum standards for product and building efficiency. They will offer consumers alternatives to $4-a gallon gas by stopping transit service cuts in the short term and expanding transit, walking, and biking alternative in the medium term. They will encourage better fuel economy in cars through financial incentives, and encourage utilities to help their customers to lower their bills by allowing the utilities to earn more to the extent that they succeed in reducing customer bills.

All of these proposals have enjoyed bipartisan support and there is no reason to not move forward with them now, other than the lack of attention and thought devoted to solving the root problems of the economy. But without this attention, we may be stuck with abortive recoveries.