The Administration and Congress have decided that a massive, debt financed, increase in government spending is correct public policy. This policy is marketed as a stimulus evoking the image of an after dinner restorative for a glutton. The stimulus will fail for 3 reasons that people in power today ignore but are surely not ignorant of since the current US regime assures us it is intelligent, well read, sophisticated, honest and hard working. We have their word for it.
The 3 reasons why the stimulus will fail in the US (as it will in the EU) are:
1. Foreigners will not bail us out
The US plans to issue trillions of dollars in new debt in the near to intermediate future. Americans either lack the resources or the appetite to buy much or even a majority of this debt. Foreigners are expected to be the principal source of financing.
The 5 largest holders of foreign reserves are, in descending order, China, Japan, Russia, Germany and Taiwan. Of these, Japan, Germany and Taiwan are nominal(but not reliable) allies while Russia and China are adversaries. China’s reserves are greater than those of the next 3 combined. For several years, these nations have been very large buyers of US treasuries, which financed US deficits and enabled both the government and scores of millions of consumers to live beyond incomes and earn beyond worth.
Foreigners have 3 reasons for investing in US government bonds and notes: national security (Japan and Germany in the 1970s and 1980s because the US protected them from the Soviet Empire and, until recently, Taiwan because the US protected it from China); market preservation (lend America the money to finance imports; as long as we over consumed, the rest of the world could enjoy export driven prosperity: our various domestic consumption and speculative bubbles became their export bubbles) and desperation (nowhere else big enough to park all the surplus dollars).
These reasons have now evaporated or are evaporating. Each of these 5 nations faces the same major economic problems, which are a squeeze on exports accompanied by contracting home markets. The problem is acute for Russia and Japan, becoming more serious for Germany and Taiwan and an increasing challenge for China which faces deep structural and demographic weaknesses that only high economic growth can disguise. Accelerating reverse internal migration in China and a crumbling real estate market suggest simultaneous unrest in both urban and rural communities lies ahead.
The response of each nation will be similar, which is to turn inward, use their financial surpluses to subsidize internal consumption and failing companies. Russia has experienced the most rapid depletion of foreign reserves in its modern history; if current, quite grim trends continue, Russia may be forced to be a net seller rather than a net buyer of US and EU government debt within 6 to 9 months; Japan’s exports have fallen faster than at any time since WW2 and China’s economic growth has now plunged below the worst case forecasts of its own government. Japan has admitted that it faces a long and deep recession and can do nothing to avert it, despite its elaborate stimulus plan. China concedes that its economic challenge is a test of the ability of the Communist Party to maintain its monopoly on power. Russia has failed in multiple efforts to defend the ruble and mitigate capital flight.
Foreigners, therefore, now have much less capacity to buy US treasuries than they did a year ago even as the US Treasury plans to issue vast amounts of new paper.
Moreover, most of the US debt held by foreigners has a maturity of under 3 years so there is an impending refinancing problem of monumental proportions for the US.
2. Confidence, not cash, is in short supply
The true currency of free and fair markets is confidence.The real currency of collectivism is coercion. Confidence has a higher multiplier than coercion. Confidence leads to enthusiastic innovation; coercion to sullen compliance. The value added to the economy from innovation far exceeds that from compliance. The current economic policy of the US is to replace confidence with coercion and staple this swap to an enormous increase in the supply of dollars that are backed by no assets at all.
Savers are told they can get no return on their funds and investors are told that bad investments will be salvaged while good investments will be savaged; bad managements will be coddled while good managements will be pilloried; bad judgments will be rewarded while good judgments will be punished. In this environment, confidence in all the major institutions of the US government (except the military) is plummeting. Americans who still have both investable resources and common sense (maybe 10% of all adults in the US, if that) are driven to hoarding cash and avoiding entrepreneurial risk. A significant portion of these people, who are essential to any revival of market based innovation, growth and productivity increases, are even spurning US Treasury investments because they believe US government debt is the new big bubble. These people understand that every dollar the government spends on low value added mandated programs will be at the expense of a dollar of private spending on high value added projects and ideas. They know why North Korea is not the most prosperous nation in the world and why Venezuela and Iran are becoming poorer by the day.
The worldview of the current US government is that the cure for problems caused by overconsumption is more government subsidized consumption; the cure for excessive private debt is more public debt; the cure for private overinvestment in real estate is public overinvestment in real estate; the cure for undesirable autos made at shareholder expense is undesirable autos made at taxpayer expense. According to this governing philosophy, bad private decisions about resource allocation can be remedied by bad public decisions about resource allocation. This remarkable philosophy states that it is not the decision per se that creates problems but who makes the decision. This is change indeed.
Private investors facing the current reality, it seems, plan to go into “internal exile”, endure and wait out the US Government until, exhausted and defeated, it retreats in muttering confusion. Only then, as coercion retreats, will confidence advance. Unfortunately, a market adjustment that would have taken 18 to 24 months without coercion will perhaps end up taking 36 to 48 months with coercion.
A trillion dollars in federal spending will probably not even create a trillion dollars in net economic benefits given the high overhead associated with spending this money. A trillion dollars in tax cuts aimed at investors, risk takers, entrepreneurs (e.g in the form of a 5 year elimination of the capital gains tax) would probably lead to $5 to $10 trillion dollars in net economic benefits.
3. Assumptions are not truths
The stimulus plan is based on 5 assumptions. The world has an endless appetite for government debt; government directed infrastructure spending on small to medium sized projects that private investors shun is a sound economic idea; increasing taxes on high income families and investors has no influence on their behavior; a one time check for people who pay no taxes and are behind in utility, credit card, auto and medical bills will lead to sustained increases in consumer spending; feeding incompetent corporate managements while starving competent corporate managements will lead to vigorous job creation. In the past 50 years, governments all over the world have pursued these notions at various times. There is no instance of documented, enduring, success.
Since WW2, four factors have impelled US recovery from recessions. These are: inventory rebuilding by businesses, household spending, home construction and payroll growth. These factors are, in turn, based on rising business and household confidence and expanding profits or household asset values. None of these factors are present in the economy in early 2009. They will, of course, eventually return.
The tragedy of the stimulus plan that it will actually hinder these factors from operating, rather than encouraging them. At the end we will have lost two years and a trillion dollars in taxpayers money. Now this is not great in the life of our nation or compared to the long term wealth creating capacity of free men and women; but, for a family with no wage earners, for a young adult fresh out of college, for a small business with shrinking revenues and no political patron, and for an electorate that is both impatient and anxious, two years is a very long time indeed.