The Government Has A Clip Full Of Bullets To Fight The Next Recession

by: Larry Kummer


The manufacturing slump continues to deepen.

A toxic combo: high inventories in November and weak retail sales in December.

We're due for a recession; in February, this will tie for the third longest expansion.

The government has powerful tools to fight the next recession.

The stock market's reaction shows that investors have awoken to the rising risk of recession, although economists' models do not yet show it. Every week brings more evidence of the manufacturing slump. Today, we learned that industrial production fell 1.8% YoY SA in December; since 1934, that has only happened near a recession. But evidence shows that the downturn has spread.

The best indicator of freight traffic is DoT's Transportation Services Index. It fell 1% MoM SA in November. While not unusual for this volatile index (it fell 1.5% in February), it is down 1.1% YoY - the first YoY drop since December 2012 (the near recession that sparked fiscal stimulus and QE3).

Worse news came today. Retail sales fell 0.2% MoM SA in December; bad news since the total business inventory/sales ratio was 1.4 at the end of November (1.5 for retailers) - both unchanged from October, both too high, both record highs for this expansion.

The length of the expansion alone suggests we should prepare for the next recession. In February, it will have its 80th month birthday, a tie with the WWII boom (1938-45) as the third longest on record.

My previous article gave suggestions to you about ways to prepare. But we prepare in part on our confidence (or lack thereof) in the government's response. What will it do to fight the next recession? In other words, how much should we worry?

Many people say the government is "out of bullets". That's not so. It has powerful tools, even beyond the bold measures taken during the 2008-09 crash. Let's count them.

Important: These tools are just vital first aid. They stabilize the economy; they do not fix anything. First aid tools are designed for short use; they have awful side-effects when used as daily tonics.

(1) Fiscal Policy

"If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again … there need be no more unemployment ..." - From Keynes' great work The General Theory of Employment, Interest and Money (1936). It was an illustration, not a recommendation.

This is the big bullet. Both theory and history show that government spending provides a fast and large stimulus. They vary in effectiveness. Tax cuts do so only weakly since so much gets saved. Spending to rebuild our rotting infrastructure has powerful short- and long-term effects.

These create deficits, which erode the government's solvency (i.e., people worry that excessive debt can be paid off only by inflation or ruinous taxes). The experience of the US since 2007 and Japan since 1989 suggests the limits on deficit spending in one's own currency are far beyond what economists imagined beforehand. Some economists and financial experts have repeatedly and confidently warned of imminent inflation, hyperinflation, or a US dollar collapse during the past five years, but all have proven false.

At some point, solvency concerns become paramount, but evidence suggests that the US is far from there.

(2) Monetary policy

"But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation." - Ben Bernanke's "Deflation: Making Sure 'It' Doesn't Happen Here", 21 November 2002.

While not as fast or as effective as fiscal policy, monetary policy has advantages: the Fed can do it rapidly, without the long lag required for Presidential and Congressional approval, and can do it on a scale political leaders seldom dare.

Unfortunately, the Fed was never able to take us off the Zero Interest Rate respirator. But the experience of many nations during the past decade show that there are monetary tools only imagined before the crash.

Quantitative easing can reshape the yield curve, potentially lowering long-term rates, with powerful effects on the entire economy.

Beyond that are negative interest rates, taking 21st century monetary policy to new frontiers. William Dudley, president of the New York Fed, stated the case to CNBC on October 9: "Some of the experiences [in Europe] suggest maybe can we use negative interest rates and the costs aren't as great as you anticipate."

Negative rates have a long history. Strong 19th century banks charged depositors interest for holding their money. In other nations, market prices have pushed the yield below zero even on long government bonds. Central banks in Denmark, Sweden, and Switzerland have charged interest on the banks' excess reserves they hold.

Once a powerful tool has been used with few visible effects, it probably will get used again, and more boldly.

(3) Other tools

There are many other levers in the US government's tool box. It can suspend accounting standards to build trust, as the SEC and FSAB did for banks in Sept.-Oct. 2008, with great effect.

There is the unknown category of "structural changes". The US did these during the 1930s, but the fast halt to the 2008 crash made them unnecessary. Japan has fiddled inconclusively with these since 1989. We can only guess when and how these might be done.


"Go, sir, gallop, and don't forget the world was made in six days. You can ask me for anything you like, except time." - Napoleon to Chef de Brigade Coulbert on 12 January 1803.

The causes of the 2008 crash have been fixed, but the US and world economies remain weak. We cannot know how weak until tested by a downturn.

As we learned in 2008, an economy can crash inexplicably and without warning. Do not count on having time to prepare for a severe downturn, or even time to assess what's happening. Time is money in a recession.

Take prudent measures to prepare, without panic or fear of economic collapse. Each of us should do what we can. The government has tools to do its job. Our leaders did adequately in 2008-2010 (unlike 1928-32). Let's hope that if necessary they will do so again.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.