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The Inherent Trouble With Too Much Stimulus

Welcome to 2010!   Now that the holidays are over and last minute Tim Geithner vandalism complete, actual real economic statistics should begin to bleed out.   First up, pending home sales… 
 
ECONX Pending Home Sales M/M -16.0% vs -2.0% consensus, prior +3.9%
…Now there is a real figure and one that should surprise no one reading this blog on a regular basis. Moreover, this number was not surprising to the Fed as evidenced by the 2:00pm release of the December Fed meeting minutes:
AP: Some on FOMC said wind-down of MBS may hurt housing
DJ: Fed officials still concerned about weak labor market
AP: FOMC members said more stimulus ‘might become desirable 
While I’m not surprised by the sales figures I do find the Fed comments a bit suspect. Correct me if I’m wrong, but during the month of December wasn’t the Fed preparing mechanisms to drain liquidity? I recall something about reverse repos being applauded on CNBS (Denninger).  Meanwhile, behind closed doors the Fed is discussing the need for more stimulus! Do you think all those recent US$ bulls are feeling like suckers yet?
The Inherent Trouble With Too Much Stimulus:
During the course of 2009, the Obama administration rolled out a series of ‘initiatives’, under the banner of ’stimulus’, in the hope of restarting the economy.  I will refrain from typing a cathartic diatribe labeling the ’stimulus’ effort as misguided, futile and infantile. Better save that for a different post when I’m feeling a little more politically randy. Moreover, I’m loath to distract you from a more pressing issue: Can a pile of stimulus actually lead to long term economic health?
I sincerely wish a hearty debate could ensue. I challenge anyone in cyberspace to give me actual proof of an economic recovery at anytime throughout history that resulted from a ’stimulus’ package.  Wait! Don’t get too excited. There is a catch. I’m not interested in reading about a stimulus package built on sound ideas like tax cutting and fiscal responsibility. No, if you accept the challenge your example must sight a ’stimulus’ package built on the solid foundation of massive budget deficits and currency debasement.              
                             
While I’m waiting for a brave soul to respond, I’d like to return to the topic of awful pending home sales.  The reason for the decline was really quite elemantary.  Government incentives draw forward sales into earlier months and when the incentives end, sales drop. Without  job creation and income expansion, incentives can only do so much; eventually the well of able buyers runs dry. Moreover, constant government creation of gimmick stimulus leads to dangerous buyer learned behavior: Stop buying until the next stimulant is announced.
Perhaps the best way to understand the dangers of gimmick stimulus is to use an analogy. Allow me to take the idea of stimulus and apply it to the easily understood realm of Starbucks. We can all agree, the first cup of coffee in the morning gives some of us a much-needed jolt of the stimulus caffiene. We feel more awake and ready to go. What happens after the 3rd or, maybe, 4th cup? Yes, we have some more energy, but we start to feel a little jittery. Add a couple more cups of stimulant and we begin to feel downright sick and are completely unproductive. This is a perfect example of the oft cited law of deminishing returns.  The unchecked use of any stimulus will lead to a decrease in productivity and usually health problems. I submit to you, the same principals hold true in economics.

Rosenthal Capital Management runs the Fortune’s Favorite Family of Funds, including Fortune’s Favor I, Fortune’s Favor Precious Metals and Fortune’s Favor Offshore. For more information visit www.rosenthalcapital.com


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