Nothing Has Changed

It is apparent to me that the factors that underlie the causes of our boom-bust cycle still exist. Nothing has changed.

While the President's message to the nation was optimistic, much of his speech was dedicated to telling us how much we need the federal government to become "winners" in a globally competitive world. Alas, I believe that it is the free market that is needed to spur economic growth, not more government spending.

I found the speech rather depressing in the sense that the Administration is still planning more spending on "infrastructure" including green energy, education, and physical repairs. Unfortunately, none of those things will contribute in any way to growth. My argument is not that we don't need roads, bridges, and schools, but that more spending on these things will not result in our ability to be more competitive or help to revive our economy.

I have written extensively on this blog about the failures of the economic policies of the last two administrations. It is clear that nothing has been accomplished by any of the spending projects and bailouts that were supposed to have bailed us out. Recently a Fed paper tried to justify the bailouts as having saved the world from collapse, but it was nothing more than "curve fitting" to achieve a desired result.

There is no believable evidence that bailouts or fiscal stimulus has done anything positive for the economy. In fact, it is far easier to weigh and demonstrate the damage to the economy of such policies. I and others would argue that all the negative consequences the advocates of bailouts predicted would happen without a bailout happened anyway.

The numbers speak for themselves.

I propose to you that nothing has changed on the policy front that would do anything to revive the economy. While I believe that reducing taxes is a benefit to taxpayers, the Laffer Curve doesn't always work because it depends on the underlying economic problems. Presently those problems are not a lack of spending as almost all Keynesians, Neoclassicists, Monetarists, and econometricians believe. It bears repeating that if we could spend our way to prosperity, then countries like Zimbabwe would be rich.

Presently what the economy needs is capital to fund expansion and it appears that such capital is lacking in the economy, or the economy would be growing. By spending more the federal government only reduces the pool of available capital to entrepreneurs, drives up the cost of capital, and results in more debt piled onto the backs of future generations. Further, QE only serves to diminish the supply of "real" capital. By real capital I do not refer to the money that the Fed creates from thin air, but actual savings resulting from production and other economic activity.

I continue to monitor the numbers every day and while there are some glimmers of improvement, they don't amount to a trend. I see things such as an improving manufacturing sector but it is almost like a mirage, shimmering in the distance: there is an unreal quality to it. If the dollar should go up, if Europe continue to have fiscal crises, and if inflation becomes rampant everywhere (a not unreasonable scenario), then exports would suffer.

So what do we see on the policy front?

• The Fed has agreed to continue ZIRP and says it's too early to withdraw QE. I interpret this as the Fed's admission that it doesn't know what to do to revive the economy, and that this is their last shot at it. As long as unemployment remains high, and I believe that will be the case, I would expect QE to continue and that it is likely that we will see more, perhaps a QE3.

• The president gives lip service to cutting the deficit but says we've got to "win" in the race for international success by spending more on infrastructure, green jobs, and education. Since that hasn't helped so far, we shouldn't expect it to work now. It would be wise to look at Japan for guidance. They have done these exact same things and they have failed too. Moody's announced today that it is cutting Japan's sovereign debt rating because of high sovereign debt.

• The Administration continues its mercantilist policies and scapegoats China for the failure of our long term policies that have hindered US competitiveness. Those policies include high corporate income taxation, capital gains taxes, bureaucratic barriers, and giving unions broad power to hamper productivity by outdated work rules, too high wages, and work disruption through strikes and intimidation. The best thing it could do is leave China alone and get out of the way of companies who wish to export.

• Housing continues its decline and foreclosures are still on the rise. Yet Senator Barbara Boxer wishes to recreate the bubble by lowering loan standards to allow people to refi:

The Helping Responsible Homeowners Act of 2011 would remove barriers, such as loan-to-value requirements, in order for certain borrowers to qualify for a refinance.

Risk-based fees on loans for which Fannie Mae and Freddie Mac already account for the risk would be removed, and lenders would be prohibited from dismissing second mortgage borrowers. Underwater borrowers would also be eligible to refinance.

"At a time when millions of Americans have been forced out of their homes, this legislation will ensure that homeowners who make their payments on time will be able to refinance their mortgages at current low rates so they can stay in their homes," Boxer said.

She added that consumer spending would indirectly increase because of the bill because homeowners would have more disposable income.

This shows ignorance of basic economics. We are still trying to get through the housing crises that vastly over-produced and overvalued housing. There have been some basic reforms to the villains, Freddie and Fannie and now Mrs. Boxer wishes to undo all that for purposes of political expediency. In other words, the taxpayers are to be put back into the business of guaranteeing reckless lending behavior. Also, it won't spur the economy. All that money the borrowers save on their mortgages will come from the employees of the banks who have less income to spend themselves. It's the old Robbing Peter fallacy.

• Adding to that folly, I see where bankers are fighting the new Financial Accounting Standards Board's mark-to-market rules that were adopted to reduce banks' reckless lending behavior. Instead of using current market value in valuing bank assets, FASB has backtracked under bank pressure and has allowed them to use cost as the basis for value. What this means is that if an asset has collapsed in value but the borrower is current on the loan, the bank need not take a hit to capital by reducing the asset to market value. In essence they can keep on lending as if the market had no impact on them. It is a ringing endorsement for zombie banking. More on this later.

Folks, it just more of the same. Don't read their lips, watch what they do. My forecast of stagnation and inflation still stands.