The worst-case scenario is not about us

By Jim Jubak

Hey, Ben Bernanke, it's the 21st century. Wake up! We -- and that includes the U.S. Federal Reserve -- live in a global economy now.

Because the Federal Reserve and the other big central banks in the developed world continue to behave as if their jobs were to manage economies that stop at their borders, they are about to drive us all off a very steep cliff.

In typically terse statements after meetings of the Federal Reserve's Open Market Committee, the group that sets short-term U.S. interest rates, Bernanke and Co. often issue a statement summing up the risks to the economy. Here's the one issued after the March 28, 2006, committee meeting:

"The Committee judges that some further policy firming may be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance. In any event, the Committee will respond to changes in economic prospects as needed to foster these objectives."

Wrong. Wrong. Wrong.

The worst that could happen

I understand how somebody, especially a banker, can say that it may be necessary to raise interest rates further in order to keep risks to economic growth and price stability roughly in balance. But I can't for the life of me fathom how anybody, even a banker, looking at the globe today can see price stability and economic growth as roughly equivalent goals.

Here's how the world looks to me.

On the one hand, if inflation creeps upward from its current 2% to 3% range, bondholders and lenders would see a steady erosion of their capital. They might demand higher interest rates in that situation, making it tougher and more costly to raise capital, and slowing economic growth.

What's the worst than could happen? At some point in the future, we might release the genie of inflation expectations from its prison. People might start to expect price increases and demand wage increases that lead to more price increases which then produce more wage increases. Before you know it, we're headed right back to the 1970s with double-digit inflation and interest rates and stagnant growth. Been there. Done that. Don't especially want to go back.

Slowed corporate profit growth?

On the other hand, if the Federal Reserve, the Bank of Japan and the European Central Bank raise interest rates and reduce economic growth, corporate profit growth might slow, stalling the stock market. Instead of growing slowly, average wages might actually go into retreat for us all. More people would be unable to find good jobs, decent-paying jobs, or just any jobs at all.

What's the worst that could happen? How about this one: The developed world's central bankers could squeeze a little too hard and slow growth too much. Squeeze hard enough and that might produce a recession in the United States, the worry seems to go, because the U.S. economy is already slowing, home buyers took on too much debt to buy over-priced homes, and higher energy prices have left U.S. consumers feeling tapped out.

But that's only the worst if you insist on the same kind of parochial, border-bound thinking that I think is so dangerous when the Federal Reserve does it.

The worst-case scenario doesn't involve mortgage holders or consumers in the U.S. at all.

Scenarios facing China and India

The worst case involves two little countries called China and India. To keep even with the population growth and the number of new workers entering the workforce each year, these two economies have to grow by something like 7% a year. That's 7% a year, year-in and year-out, just to stay even.

To give their burgeoning populations a bit of hope that the future might be better than today, they have to do better than 7%. To defuse the social tensions that arise when some people receive more of the benefits of growth than others and receive them sooner rather than later, they have to do better than that. To put away a little bit for the day when these huge populations begin to retire, they have to do better than that. To put away a little bit so there's something to invest in providing clean air and clean water, they have to do better than that.

 1 | 2 | next >