Summary: Team Obama has chosen the soft path to economic recovery. Spend money while stalling any substantial reforms. No confronting our deep structural reforms, just wait for the recovery due later this year. It might work — reliable forecasts are difficult or impossible these days — but its failure would leave us far weaker, making a next round of solutions more difficult.
The Obama Administration’s economic strategy rests on two assumptions:
- The economy will recover sometime in the second half of 2009, and
- If the recovery does not arrive on schedule, then they can take stronger measures.
I believe both are wrong.
Will the economy recover soon? We are on unknown territory, with governments around the world applying fiscal and monetary stimulus on a scale never before attempted (outside wartime). The total stimulus — expansion of the Fed’s balance sheet plus fiscal stimulus — is 17% of GDP. It’s aprox 8% in Europe, and a staggering 26% of GDP in China. (figures from a new report by Nomura). There are few post-WWII precedents for this, so forecasts of econometric models are unreliable.
Jim Grant, editor of Grant’s Interest Rate Observer, put this in perspective:
In {the April 3 issue} of Grant’s Interest Rate Observer, Jim Grant put together a fabulous chart showing the amount of stimulus as a percentage of GDP, both monetarily and fiscally, for this downturn compared to the last 13 recessions. For those, the cumulative monetary stimulus was about 6%, while thus far in this single recession, it has been 18%. In those prior recessions, the amount of fiscal stimulus as a percentage of GDP summed to about 33.2%.
Thus far — and I do emphasis thus far — the government has only ginned up 11.9%, which sums to 29.9% for the combined stimuli, compared to a cumulative total of 39.3% of the prior 13 recessions. When this recession is compared to the Great Depression, the amount of stimulus having been applied so far is almost four times as high, even though thus far GDP has dropped only 1.8%, versus 27% in that collapse.
— The Daily Rap, Bill Fleckenstein, 20 April 2009 (subscription only)
{W}hat is truly momentous is the government’s response. Nothing like it. So there have been 11 recessions/depressions since 1929. On average, the sum of the fiscal and the monetary response as we index them is like 2.9% of GDP. What is shaping up now, in sight and prospectively, is 29% of GDP. Ten times the average response. Now in the Great Depression, before the dawn of Keynesianism, this is three times that response for a recession that is 1/15th the magnitude of the Depression. … They’re probably not done yet.
— Jim Grant, interviewed by Larry Kudlow. Source: transcript of the 15 April broadcast of The Kudlow Report
This is an experiment on a scale never before attempted. In some ways it makes the New Deal look like a cakewalk, a vastly larger stimulus by a far more indebted government. We can only wait to see the results. But if it does not work, then Team Obama can still respond effectively. At least, that is their assumption.
Policymakers are loath to amputate when they might be able to nurse a limb back to health. Some think in terms of reversible error – preferring to take steps that can be revised later if necessary – and there is a general aversion to taking high-risk steps that could do more harm than good. “Governments should practise the same principles as doctors – first, do no harm,” said Mr Obama this month, rejecting pre-emptive government takeovers that could threaten confidence.
An important feature of many policymakers’ thinking is that this is not their last shot – that they are still early enough in the life of the crisis to come back and try again with other, more forceful measures if it does not work.
Still, the administration’s capacity to muster what it takes to intervene decisively could diminish over time. At MIT, Prof Johnson says the politics of bail-outs could get worse rather than better, while Mr Obama’s approval ratings could diminish.
Yet even critics think the administration may get lucky and do just enough to allow the US to muddle through. … “It could all work out – who knows?” says Prof Rogoff. “But there is certainly a chance that what they are doing will end up costing more and prolonging the recession.”
— From “Steeled for stress“, Financial Times, 20 April 2009
This is a reasonable but high-risk strategy. It avoid confronting our deep structural problems, avoids a death-struggle with the powerful financial oligarchs — it’s the safe path that risks destruction. Another possibility is that the this passivity — spending money but otherwise doing little — will allow the rot to spread through the economy. Confidence might diminish, along with Obama’s political capital.
This strategy recklessly burns our financial resources fruitlessly attempting to stabilize the banks. Worse, it squanders Obama’s greatest resource: time. Time is the most important and scarcest resource. Obama needs faster and bolder action now, with reorganizing and recapitalizing the banks as step #1. As Napoleon wrote to Chef de Brigade Coulbert (12 January 1803):
“Go, sir, gallop, and don’t forget the world was made in six days. You can ask me for anything you like, except time.”
For more about this see
- Obama makes his first major policy error, 27 February 2009 — My analysis.
- “Irreversible Damage: Why Little Action on Banking Can Do Great Harm“, Simon Johnson and Peter Boone, New York Times, 23 April 2009.
Afterword
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For more information from the FM site
To read other articles about these things, see the FM reference page on the right side menu bar. Of esp interest these days:
- about the Financial crisis – what’s happening? how will this end?
- about the End of the post-WWII geopolitical regime
- and some Good news about America, a collection of articles!
Some posts about solutions to the financial crisis:
- A happy ending to the current economic recession, 12 February 2008 – The political actions which might end this downturn, and their long-term implications.
- Slow steps to nationalizing the US financial sector, 7 April 2008 — How this will change our society.
- How should we respond to the crisis?, 24 September 2008
- A solution to our financial crisis, 25 September 2008
- A quick guide to the “Emergency Economic Stabilization Act of 2008″, 29 September 2008
- The last opportunity for effective action before disaster strikes, 3 October 2008 — How to stabilize the financial system.
- Effective treatment for this crisis will come with “The Master Settlement of 2009″, 5 October 2008
- Dr. Bush, stabilize the economy – stat!, 7 October 2008
- The new President will need new solutions for the economic crisis, 9 October 2008
- New recommendations to solve our financial crisis (and I admit that I was wrong), 23 October 2008
- A look ahead to the end of this financial crisis, 30 October 2008
- Expect little or nothing from meetings like the G20 – or the Obama Administration, 18 November 2008
- Everything you need to know about government stimulus programs (read this – it’s about your money), 30 January 2009
- Bush’s bailout plan is now Obama’s. His quiet eloquence guides the sheep into the pen, 30 March 2009
