Rupert Cornwell: Obama's plans for change will not escape this slump intact

Obama's agenda: 2. Economy

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The financial crisis and deepening economic recession are the biggest problem facing Barack Obama – and the problem is getting worse by the day. The slump, and the colossal federal deficits required to escape it, will thus slow down, if not derail, other parts of the incoming president's domestic programme, and perhaps his international agenda as well.

So far, Mr Obama has refused to become involved in foreign policy-making, his spokesmen repeating mantra like "the US has only one president at a time." The economy, however, is another matter.

As banks plunge into a second cycle of massive losses, caused by increasing bankruptcies and losses on credit card and commercial real estate business, he has already asked the outgoing Bush administration to authorise the second tranche of last autumn's $700bn (£477bn) bank bailout package, despite strong criticism from many Republicans and even some Democrats on Capitol Hill.

If lawmakers refuse the request, one of Mr Obama's first actions as president could be the veto of a measure passed by a Congress controlled by his fellow Democrats, so to allow the rest of the money to be released.

The real centrepiece of his policy however is the mammoth stimulus package on which his economic team and Congressional leaders are working, and which Mr Obama wants to have on his desk for signature as soon as possible after taking office.

The measure, worth $800bn or more, is now likely to contain $300bn of tax cuts, as promised by Mr Obama during the campaign (except that Bush-era tax cuts for the very wealthy will be allowed to expire naturally next year, instead of being immediately repealed).

The cuts will be accompanied by $500bn of government spending, including money for financially strapped states, $90bn for healthcare benefits for the poor and $85bn for road, bridges and other infrastructure – including "green" projects.

The plan will pass. But to the dismay of fiscal conservatives, it is bound to increase the 2009 federal deficit of an estimated, and record, $1.2trn that the new administration is inheriting. Mr Obama has stressed the importance of getting the budget back into balance once the emergency is over. That however will be easier said than done.

In the meantime, the President-elect warns bleakly that, whatever action is taken, the economy will get worse before it gets better. No one expects the package to restore growth overnight. Its immediate purpose is to prevent a deep and painful recession turning into an ordeal comparable to the Great Depression – a nightmare that still haunts America's collective folk memory.

In some ways, the country's dire economic situation works to Mr Obama's advantage. It is accepted that nothing he or his-star studded team of advisers can do would likely stop unemployment rising from the present figure of 7.2 per cent to 9 or even 10 per cent by year's end, and the economy from contracting until autumn 2009 at the earliest.

Barring spectacular blunders, he will thus enjoy a longer honeymoon with voters than most new presidents. Indeed, so extraordinary are the times that even Republicans seem ready to overlook the failure of the Treasury Secretary-designate, Timothy Geithner, to pay federal self-employment taxes a few years ago – a sin that in normal circumstances might well have capsized his nomination. Now, friends and foes alike recognise that the country's economic woes do not allow for a vacuum in decision-making while another nominee is found.

But the overriding need to right the economy could tie Mr Obama's hands elsewhere. He will find it hard to deliver quickly on his campaign promise to carry out a costly overhaul of the dysfunctional US healthcare system, at a moment when budget resources already are under such intense strain.

Inevitably too, the pressure for energy policy reform, shifting away from imported oil to cleaner, renewable sources, has diminished with the plunge in oil from more than $140 a barrel to below $40. But some states – perhaps even the federal government – are planning to use the drop in pump prices to raise gasoline taxes for the first time in years, to recoup some revenue lost to recession.

On the foreign front, the acute financial weakness of the US, reliant on countries like China to finance its trade and current account deficits, will also impose constraints. It can only speed up the pull-out of US forces from Iraq, and end an occupation costing at least $10bn a month.

US economy: The current picture

* US economy shrank at an annual pace of 0.5 per cent July-Sept 2008.

* Retail sales fell for the sixth month in a row in December, by 2.7 per cent.

* Unemployment hit 7.2 per cent in December, a 16-year high.

* The trade deficit narrowed to $40.4b (£27.6bn) in November and import levels fell.

* Producer price index fell 1.9 per cent in December, capping the first annual drop since 2001.

* Fuel is down to about $1.79 a gallon.

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