Will Government Spending Work?

Includes: DIA, QQQ, SPY
by: David White

Yesterday Secretary Geithner unveiled plans to stabilize the banking system (and hopefully the housing market). These all involved the government spending money. Estimates are running as high as $1.5T or more (some of it private). Then too there is the stimulus plan. For this the government is spending approx. another $1T. This all seems a little like haphazard spending. Will it do any good?

In the short term I think you would have to say the answer is yes. The stimulus plan, however misaimed it may be in many ways, will go a long way toward arresting the downward spiral we have gotten into. Its overall effect may not totally stop job losses, but it is almost assuredly going to slow them down. The Treasury proposed programs will go a long way toward restoring the credit markets. This will allow more businesses to survive the short term problems this recession has created.

For instance, do you really want every company that is suddenly selling 50% less of its goods to cut 50% of its staff due to short term market fluctuations? This would only lead us further into a downward spiral of job losses. Most of these temporarily hit companies will recover as the economy recovers. It will cost them more to fire excessively now. Then they will have the added expensive of retraining workers 6-12 months from now as we start to come out of the recession.

In the case of technology companies, excessive firings now would also slow down technical innovations. It would delay projects. It would make U.S. businesses less able to compete on a worldwide basis. This would have a long term negative impact on the U.S. economy. It is simply better to allow some of these companies to borrow short term to avoid these losses in time, in innovation, in human capital, and even in overall real money.

One might then ask, won't all this excess spending lead to inflation, and isn't that bad? The answer would seem to be that it will lead to inflation eventually. Is that bad? In the short term it is definitely not bad. We are currently in a deflationary state in which housing prices all over the country are going down. A lot of people's net worth is wrapped up in their houses. A lot of banks are dependent on the same houses retaining their value to maintain their viability. If we can stop the housing prices from going down, that is a good thing. The banks won't be able to survive if we do not achieve this goal. The U.S. economy cannot survive without the banking industry. Stimulating inflation is an effective way to combat deflation. The houses become worth less compared to other items, such as food. However, they retain their book value, which allows the banks to survive. The individual owner effectively loses money in this process, as his equity has gone down in real dollar terms.

However, this inflation preserves the book value of the home. It preserves the margin of equity. The owner still has the freedom to sell the home, if the owner desires to move. This situation is highly preferable to people being stuck in homes paying for mortgages that are underwater. It is preferable to the banks having to absorb losses due to foreclosed homes that are underwater. It is preferable to no one being able to buy a home because the banks are gun shy of having to absorb more bad real estate loans. Eventually the Fed will step in to stop inflation by raising rates, etc. The government can control inflation to a large degree. It doesn't have to let it go on wildly forever.

Then you ask, what about bonds? Doesn't this destroy the value I have in my bonds? Won't the eventual higher interest rates destroy the value in the bonds I buy now? The answer is obviously yes. However, this may not be a completely bad thing. U.S. citizens own some of this debt, but we have been a debtor nation for decades now. The Chinese own a lot of the bonds, as do the people of other countries. If inflation of the U.S. currency occurs, it means we owe them less, so this is not a completely bad thing. The bad part is obviously that they will be unwilling to buy more of our debt if they see it as a completely losing proposition.

However, in the same way people re-invest in the stock market after it has fallen, people come back to the bond market too. Losses of investors in the U.S. bond markets will likely only be temporary as long as the U.S. economy is reasonably healthy. Ultimately the real question then becomes what steps we are taking longer term to make sure that the U.S. economy is healthy in the future.

I don't have all of the answers to this. We do need to get rid of the trade deficit though. We have been ignoring it too long. We knew in the 1980s that we had to do something about the trade deficit. The deficit was the hot topic as the markets crashed in 1987. Somehow we never did anything about it. We have managed to ignore it until now. Now we have emerging economies that are putting pressure on the price of all raw materials, especially oil. If we try to persist in being a debtor country in this environment, we will do nothing but spiral downward. The emerging growth countries will choke us with their new appetites (increased demand means increased price) for the materials we used to have exclusive access to. The U.S. economy will simply wither and die.

That is why the energy initiatives are so important. That is why we must produce more ourselves. That is why initiatives to recycle raw materials effectively are important not just ecologically, but economically too. President Obama needs to bring a halt to the current downward spiral. Then he needs to remember to keep the "pedal to the metal". He needs to follow through on not just a short term recovery, but a long term plan for economic growth for the future. It is crazy for U.S. companies to offshore many of their jobs for marginal if any more profit. Often there are many hidden costs involved in this.

Broadcom (BRCM) probably has a more reasonable compromise model. It is crazy to perpetually import high tech workers, when many very qualified U.S. citizens need jobs. A large proportion of these workers eventually make the U.S. their home. However, a more important minority return to their original homelands to start their own competitor companies using technology they have essentially stolen from U.S. companies. Does it make sense to sponsor this on a widespread basis longer term? Does it make more sense to make sure we have children here with the technical skills to fill these jobs?

From what I see, we are now cutting back on education dollars. Is this going to help us have the ability to fill the highly skilled jobs of the future? Are we instead just getting farther from our ideal? I hear Bill Gates lobby perpetually for more H-1B visa workers. I never hear him lobby for more education for our children. One need is for immediate gratification. The other is for a long term strategic plan. We all know which need is more likely to be served. Is Bill Gates the oracle we should be listening to? Is he just advocating immediate gratification over long term success? Obviously some combination of these two needs to be put in place. President Obama needs to recognize this as a major goal. I hope he will.

In terms of the markets, there seems to have been a negative reaction to Secretary Geithner's plan (or lack of a detailed plan). The SPY has now fallen back below the $85 breakout point of a few days ago to its current $83. We can keep falling from here, or the markets can recover. We will have to see what tomorrow brings (or perhaps just later today). The Nasdaq did break solidly above its 50-day moving average. Not surprisingly it is the index that fell the least yesterday. Perhaps a quick approval of the stimulus package will help the market to stabilize. Short term anything can happen. Longer term we need to do well.

I hope the powers that be in Washington are keeping their eyes on the future as well as the present. We need to become a net exporter again. That should be their clear longer term goal. It should be a high priority. We need to become a country that educates so well, other countries want to import our young men and women to help them, not the other way around. That needs to be a priority. Spending less on our children (and importing more highly educated young men and women) is a losing strategy for the U.S. That has to change. Bill Gates's easy tech people strategy has clearly decreased our perceived "need" to educate our own children. That needs to change.