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Federal Reserve has few options as economy flirts with 'double dip' recession

The US economy is drifting toward recession, but when Federal Reserve policymakers meet next week on June 19 and 20, they will have few tools to turn things around.

Jobs creation slipped to alarmingly low levels in April and May. Wages, which were rising modestly through most of the recovery, have been virtually flat for three months. An already tough labor market for both job seekers and the employed is getting worse.

First quarter productivity was down sharply, indicating businesses have more workers than needed to meet demand and must soon lay off employees if sales don’t pick up. However, deteriorating conditions in Europe and China, and falling values for the euro and yuan against the dollar, indicate US exporters and import-competing businesses will face tough environment this summer.

In manufacturing, the bright star of the economic recovery, new orders declined the last two months, and manufacturers and service businesses, polled by the Institute of Supply Chain management, report falling prices. Businesses slashing prices to maintain sales is an ominous precursor of more layoffs.

The Federal Reserve has already pulled all the levers that might make a difference. Short-term interest rates—such as the overnight bank borrowing rate and one month and one year Treasury Bill rates —are already close to zero.

When the Federal Reserve Open Market Committee last met on April 25 more bond purchases to lower long-term Treasury and mortgage rates were on the table. Since then, investors moved cash from risky European government bonds to US bonds. This has pushed 30-year Treasury and mortgage rates to near record lows, preempting the effectiveness of any additional Fed initiatives.

A statement that the Fed intends to keep short rates near zero beyond 2014 would have little effect on investor and home buyer psychology—already, no one expects the Fed to push up interest rates in the foreseeable future.

Central bank policy can help dampen inflation when the economy overheats and lift borrowing and home sales a bit when it falters, but it can’t instigate faster growth when the president and Congress fail to address structural problems.

Demand for US products is burdened by huge trade deficits on oil and consumer goods with China—both result from government inaction.

Two years ago, President Obama warned China he could act if it did not abandon its cheap yuan policy, which both he and Federal Reserve Chairman Bernanke admit is slowing U.S. growth, but he hasn’t taken any substantive steps. Stiff restrictions and prohibitions on drilling in the Gulf, off the Atlantic and Pacific Coasts, and in Alaska are reducing U.S. production some 4 million barrels a day and doubling net imports.

Monetary policy can’t compensate for Oval Office gaffs like those.

Americans still pay twice what Germans do for health care—and get inferior results. This adds about $4 to 5 an hour to the cost of providing workers with health benefits—something ObamaCare will compel—and makes adding jobs in America too expensive.

Ditto the cost of education. Young folks saddled with huge loans to repay can’t be consumers even when they have decent jobs—yet American higher education seems to exist to mainly make hospitals and health insurance companies look efficient.

Most of the Dodd-Frank reforms are in place, and it has permitted the biggest banks to control 60 percent of US bank deposits. JP Morgan and its Wall Street Brethren continue to run casinos, but won’t make nearly enough loans to regional banks or small and medium sized businesses—simply, gambling creates million dollar bonuses, old fashioned lending does not.

President Obama’s big stimulus spending and low interest rates offered a period of grace to fix those problems but that opportunity has been squandered.

Chinese currency mercantilism, oil imports, exorbitantly expensive health care and education, and the big bonus culture on Wall Street are smothering U.S. growth and changing America for the worse—America is simply become too much like Greece and not enough like Germany.

Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, and widely published columnist. He is the five time winner of the MarketWatch best forecaster award. Follow him on Twitter @PMorici1.