We all know the story of the imperious little girl and the saga of the three unwitting yet hospitable bears.
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Why the subservient bears didn’t chow down their blonde interloper after she’d been so rude as to eat their porridge and bust up their furniture is one of the literary mysteries of our time.
My guess is they were simply thrown by her chuptzpah.
In the weeks and months ahead, as the economy lurches towards recovery, policymakers like Fed Chair Ben Bernanke, and to a lesser extent Treasury Secretary Tim Geithner, are going to have to wrestle with their own Goldilocks enigma.
Too Hot? Too Cold? Just Right?
Will the economy be too hot from all government stimulus and intervention?
Will it be too cold because of the mounting unemployment and flagging consumer confidence?
Or will it be just right if they simply wait for the market to sort through the mess?
The stock market has erased almost all its losses for the year. Yields on long-term government debt have returned to something like normal, and commodity prices have been surging, all evidence that the worst of the economic crisis may have passed.
While investors ponder their next moves, the economy still is confronted with a confounding array of risks.
At the end of last week, the U.S. Labor Dept. announced the lowest job loss numbers since September. Surprisingly, the stock market seemed unaffected by this relatively good news. At the same time, driven by worries about inflation and higher interest rates, U.S. treasuries had their worst day in nine months.
Growing optimism about the economy and the prospects for an earlier economic recovery have started to send commodity prices higher. On Friday, for example, oil briefly peaked above $70 a barrel.
Anxiety about inflation could prompt policymakers to push interest rates higher. This could put a damper on recovery in the housing market. At the same time, escalating commodity prices may act as an additional drag on the economy, causing unemployment to push higher. In turn, this could lead to an upswing in mortgage defaults.
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Many economists are hopeful that the government stimulus, which has yet to hit the economy will unleash pent-up consumer and business demand. On the other hand, there are growing concerns that the stimulus may cause the economy to run too hot, forcing the government to slam on the brakes by pushing up interest rates.
Higher interest rates may prevent the economy from overheating, but also may exacerbate unemployment, causing more people to fall behind on their debts, further hurting the housing market, which may lead to a new wave of bank losses.
In an odd twist that is emblematic of the challenge facing policymakers, several of the major banks that received passing grades following the government stress tests now are seeking to return some or all of the federal liquidity aid they received from TARP.
Why They Can’t Pay Back Debts
With all the strings attached to the bailout money, and based on their recently demonstrated ability to raise capital from the private sector, banks like JP Morgan, Goldman Sachs and Bank of America are itching to pay back the federal government. The federal government, however, has yet to decide whether it will let them.
This reluctance to accept repayment from the banks may reflect the uncertainty policymakers are feeling about the road ahead. Should the economy stumble, causing the banks to confront additional solvency issues, they don’t want to be forced to navigate the potential political landmines associated with engineering yet another financial rescue program.
The future of the U.S. dollar is also a nettlesome issue.
A weaker dollar tends to make U.S. exports more attractive, but it also engenders higher commodity prices. A weaker dollar undermines U.S. consumer buying power and hurts the value of savings.
A preview of this potential outcome has dogged the market lately, contributing to the jump in Treasury yields and a surge in gold prices while trimming more than 9 percent from the dollar's value against the world’s major currencies over the past three months.
From all appearances, policymakers seem to be pre-occupied with preventing an inflationary scenario. While this may represent their public face, they still quietly dread any actions that may trigger a deflationary skid.
In the children’s story everything turned out “just right.”
Given the disparate assortment of uncertain and interrelated variables now confronting the economy, government policymakers may have to sample more than just one bowl of porridge before they’re able to get it “just right.”
John Cohn is a senior partner in the Globe West Financial Group, based in West Los Angeles. He may be contacted at www.globewestfinancial.com
