Those Illusory Stimulus Packages

Obviously those working on President-elect Barack Obama’s $1 trillion stimulus plan are in tune with the vision of Ben Bernanke and Hank Paulson: if you keep the financial system alive long enough, the valuation flaws within the system will rectify themselves. Maybe so, if you stay alive (financially) long enough. Because those calling a market bottom (DIA, QQQQ, SPY) now are, almost entirely, relying on the ability of the wave of recently announced stimulus packages, domestically and globally, for the restoration of consumer demand and for nursing family balance sheets back to health.

Well before the term “bailout” gained currency in world capitals, lawmakers in the major emerging markets had dedicated a total of $1.25 trillion to infrastructure spending in 2008. Given that the rubber has still to hit the road for even a fraction of the $1.25 trillion-linked projects, the post-September stimulus packages are nothing short of illusory, without exception. Is Chairman Bernanke, a serious scholar of the economic turmoil before the Second World War, best advised to protect his legacy by declaring today that a second Great Depression is already a work-in-progress?

In April this year, a Merrill Lynch report had already forecasted that annual infrastructure spending in Africa, the Middle East, Latin America, Eastern Europe and Asia will jump by 80%-plus through to 2011, from $1.25 trillion to $2.25 trillion. During the last two months, developing-world governments announced another wave of infrastructure commitments with China leading the charge by listing $600 billion worth of proposed investments in bridges, railways, roads, dams, electricity and airports.

If one adds the Merrill Lynch revisions and the post-credit-crunch stimulus schemes to the early-2008 public works commitments already on government books, the world appears to be well on the road to the most robust of recoveries. The problem, however, is that there are hundreds, if not thousands, of existing infrastructure projects that either are in a state of extended legislation-induced delay or are proving to be ill-conceived in a rapidly deteriorating economic climate. The $1.25 trillion budgeted by the emerging markets for 2008 itself appear overly optimistic; the less said about the Merrill Lynch revisions and the stimulus-related announcements, the better.

A brief and relevant example from India should certainly highlight to the Fed Chairman the fact that there is nothing like non-productive and, in some instances, non-existent capital to lay the foundations of a depression.

India’s showpiece rural electrification scheme was targeted to touch 125,000 villages by March 2009. But deeply embedded factors like the lack of on-ground planning, widespread corruption and delayed resource allocations have left the scheme in shambles; by most estimates, less than 40% of the villages the scheme sought to cover will have access to any electricity at all by next March. Besides, it is doubtful that more than 20% of village households, who do ultimately get electricity, will be able to afford electrifying their dwellings for more than an hour or two a day. And to compound the problem, the completion of the electrification scheme, at some point in the future, requires an emergency budget allocation—35% of the original budget has simply melted away in government books.

As one New Delhi cabinet member explained, “We don’t have the infrastructure to implement big infrastructural projects efficiently and speedily and, now, with the unorganized labour market in chaos, many projects approved by parliament will just have to wait.” Almost 50% of casual workers employed in construction have lost their jobs this year, and many of them are heading back to their villages where agricultural lands allow only a hand-to-mouth existence.

In many respects, India’s showpiece electrification scheme is a microcosm of the broad underlying ailments which afflict public works throughout the emerging markets. Many similar delays will also haunt the new $1 trillion Obama stimulus plan. At some point, Chairman Bernanke, or his successor, will have to admit that the strategy of keeping the financial system alive long enough for a stimulus-triggered reversal will fail, and that nothing short of a sharp contraction in the size of the US economy will recreate genuine asset values. A deliberate contraction is the preferred route, if politics permits. The alternate is a chaotic erosion of values, akin to, but much larger in scope than, the 1929-1933 period in history.

Disclosure: Author holds short positions in QQQQ and SPY

Comments

[who:]

All well and true, but its fear and greed which drives the markets.

2008 Dec 21 12:03 PM

[DaveW:]

"Disclosure: Author holds long positions in QQQQ and SPY"

Typo most likely, author is Short QQQQ and SPY based on many recent posts.

2008 Dec 21 12:09 PM

[jepittman:]

The United States is not India. Just because India has had some alledged delays in public spending does not mean similar delays will occur here. Furthermore your assumptions that government spending elsewhere around the world will experience long delays appear to be your opinion since little in the way of evidence is offered. You should provide more than an eight month old opinion piece from a firm neck deep in bad mortgages to back up your assertions.

I have a lot of respect for the bearish arguments you make and I appreciate your point of view. However I am not convinced the world economy will soon collapse into a depression as you are suggesting. The economic problems facing the world are largely recognized by all governments and their central banks. Declining asset values are being addressed by everyone. To claim no one can do anything to counteract the problems is fine. I just cannot bring myself to bet that way.

2008 Dec 21 12:17 PM

[CautiousInv...:]

I tend to agree with most of your points, particularly that a market bottom and subsequent upturn hinges significantly on the belief that monetary policy, along with the massive stimulus effort, will turn the economy around. The problem with both policy initiatives is lag times and the singular problem with the yet to be passed stimulus act is its size and implementation. Once passed and enacted into law, I suspect it will passed down through states, counties and munincipalites........... requiring time. In the meantime, the Conference Board and other organization that measure and track CEO sentiments are predicting dire conditions for the next six months. ISM indicators show no hope as well. And housing, which led us into this mess, must recover before the recession ends if history is torepeat itself. In my mind, this puts the recovery well into the second half of 09 or sometime into 10...........meaning that the real market recovery, at the earliest, will occur sometime in the second half of 09. I have studied past recessions and concurrent bear markets and have observed that the bottoming out process involves three or four tests of market lows and that the last test occurs three months prior to the end of the recession as defined by the NBER.

2008 Dec 21 12:27 PM

[Rakesh Saxena:]

Yes, DaveW--this is a typo--probably an error at my end. I assume one of our friends at SA will pick this message--Many thanks - Rakesh


On Dec 21 12:09 PM DaveW wrote:

> "Disclosure: Author holds long positions in QQQQ and SPY"
>
> Typo most likely, author is Short QQQQ and SPY based on many recent
> posts.

2008 Dec 21 01:47 PM

[Shira Jacobson:]

Thanks for bringing this to our attention. It has been fixed.

Shira Jacobson
Seeking Alpha Editorial Team

2008 Dec 21 02:17 PM

[investor88:]

Rakesh has made very good arguments that problems persist despite all those massive stimulus packages, QE, liquidity injections and slashing of rates to zero. We have to go through the wringer before we can rebuid the economy, ie have to accept a deep recession/depression first.

I am afraid Rakesh will have the last laugh in taking a short position in QQQQ and SPY.

2008 Dec 22 07:56 AM

[Did U Think...:]

In other words, the government doesn't control the economy? Have you been learning from Ron Paul again? If so then bravo because he has been saying this for years.

2008 Dec 22 01:14 PM