Tuesday, February 17, 2009

Mortgaging Our Economic Future

And so, with the stroke of a pen (ten pens, actually), President Obama today signed into law a $787 billion dollar bill he assured us will help get the American economy back on its feet. At best, it will provide a shot-term economic jolt; at worst, it could massively devalue the dollar, contribute to a future inflationary crisis, and help transform America’s economic juggernaut into a Western European sloth.

The best thing that can be said is that it will create a placebo effect that will boost the economy. As I argued in my
previous post, the fundamentals of the bill will not be helpful, but if enough people believe it will boost our economy, then perhaps it may become a self fulfilling prophecy. If John Q. Public believes (rightly or wrongly) that this will help solve our economic woes, we can expect consumer and investor confidence to rise, which will allow America to get back to business. Of course, I suppose it’s beside the point that Congress could have just as easily caused this placebo effect by leaving the first page of the bill blank and spending zero dollars.

The alternative theory is that this bill will grow the economy by spending money that would not have otherwise been spent. The problem is that the government cannot spend money out of thin air—it can only spend a dollar by taking that dollar away from the private sector, either now or in the future. Proponents of the bill would assert—correctly—that this spending bill supplements (rather than replaces) current spending because it is 100 percent deficit spending, which means the private sector does not yet have to pay for it. Unfortunately, the irrefutable implication is that the government must gradually remove this money from the private sector for a long time to come. In short, we are mortgaging our economic future for the sake of the present.

The Congressional Budget Office—a non-partisan federal agency tasked with assisting congressional decisions by providing economic analysis—
predicts that this bill will hurt our economy in the long run. It estimates that the legislation in the short run will “raise GDP and increase employment by adding to the aggregate demand” over the next few years. However, the legislation will “reduce output slightly in the long run.” This is because the resulting debt will “‘crowd out’ private investment” in the long run. Therefore, the CBO predicts reduction in future GDP by as much as .2 percent, reflected largely in lower wages because “workers will be less productive because the capital stock is smaller.”

The bill’s economic effects are even more serious when you account for its potential to devalue our currency, which the CBO report does not seem to consider. Our
national debt stood at $8.95 trillion at the end of 2007, and equaled 65.5 percent of our GDP. The national debt presently amounts to $10.7 trillion and our GDP totals $14.3 trillion, so our national debt is now approximately 75 percent of our GDP. To put these figures in perspective, our national debt has not occupied such a huge percentage of GDP since the early 1950s—while we were paying for World War II!

This would be bad enough, except we’re just now getting started. The Congressional Budget Office already
predicted a $1.2 trillion deficit for the coming fiscal year. President Obama stated that “unless we take decisive action, even after our economy pulls out of its slide, trillion-dollar deficits will be a reality for years to come.” The Treasury is reportedly considering spending as much as $2 trillion to stabilize the financial system. Anyone care to predict what percentage of GDP our debt will consume after all is said and done?

There is no doubt that President Bush and his Republican congressional majorities committed fiscal malfeasance by overspending during the boom years; as a result, our nation’s overbearing debt makes it very difficult to justify spending increases during the bust years. Justified or not, however, the United States is spending it. I can’t help but wonder whether our trading partners who largely finance our debt—with China as our number one creditor—will continue doing so. Yes, our creditors would harm their own economic interests by inciting dollar depreciation, but it would also be masochistic of them to continue buying debt they doubt we can repay without printing more money out of thin air.

This, of course, would result in inflation. The
M2 indicator of our money supply has already increased at an annual rate of about 20 percent since August, so the Federal Reserve will already have a difficult time removing all of this excess liquidity from our system once our economy recovers. Imagine how much worse this situation would become if we're forced to essentially "inflate" our way out of debt.

Combine potential devaluation with classic monetarist inflation, and Americans will watch the price of their goods skyrocket—and our standard of living plummet. Of course, I could always be wrong. I’m still saving up the money to purchase a crystal ball and I don’t have a PhD in economics, but it seems clear that the economic stimulus plan is a recipe for disaster. How can we obtain long-term prosperity by mortgaging our economic future for the sake of temporary “stimulus” that so many people doubt will really work? Make no mistake—I do believe the economy will naturally rebound over the next year or two, due to its cyclical nature. But this “stimulus” plan will have little (if anything) to do with it, and it will simply open the door to future economic pain.

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