Government economic stimulus is powerful medicine. Just as heroin was once used as a powerful medicine.

Larry Kummer, Editor

13 years ago

Summary: Today America passed an important fork in the road, an easy exit from the massive monetary stimulus running since the crash. If the economy continues its slow growth (well below the 2% stall speed) today might have been the last opportunity for an easy exit. Today also demonstrated the madness that infects us, as investors cheered the Fed’s bad news about the economy’s slower than expected growth — and bid up asset prices. This post attempts to provide a harsh but accurate perspective on our situation.

See the follow-up post: Different answers to your questions about the momentous Fed decision to delay tapering.

“Damn the torpedoes! Full speed ahead.”

— Paraphrase of Admiral Farragut’s orders at Mobile Bay (1864). A great naval leader; he would have made a terrifyingly bad Central Banker

How did we get here
It was easy. It’s always easy to get hooked
About government stimulus programs
About the winners
Why end the fun?
Pictures of the US money supply
For More Information

(1) How did we get here?

The Fed balance sheet has grown from $800 billion before the crash to $3.6 trillion today, now under QE3 increasing at $85 billion per month. While necessary during the recession, this has a side effect, one found in a few other powerful medicines. We have become addicted. I (and many others) warned about this (the original brief version of this post was Dec 2009). Now we’re hooked. Unless we act soon (later this year?) probably much pain lies ahead.

See this excerpt from “Financial Heroin”, Don Coxe, Coxe Advisors, 16 December 2009:

… my father was a doctor in the Canadian Army in WWII, and served in the Italian campaign. He became greatly respected for his anaesthesia and pain management under battlefield surgery and rehabilitation conditions. He was cited after war’s end for perhaps having performed more anaesthetics under such conditions than any other Canadian doctor.

In discussing his experiences, he told me that he swiftly learned that the best — and frequently the only — reliable drug for the critically wounded was heroin. Soldiers who writhed in agony under other medications almost always responded to heroin. The problem wasn’t deciding whether to administer it: if morphine didn’t work fast, you didn’t waste time, you injected heroin.

The problem for the doctor came when the patient had begun to recover from surgery, and was receiving heroin. How quickly could the dosage be reduced and when would it be terminated? Although few soldiers were freed of heroin without experiencing pain and distress, it was necessary to take the drug away as rapidly as possible. Otherwise they would become addicts and their lives would be ruined — for soldiering and everything else.

… Zero interest rates are Financial Heroin.

This goes to the vital points, mostly misunderstood, about the massive fiscal and monetary stimulus governments have applied in response to this global recession. Government stimulus has several characteristics similar to heroin.

It mitigates the downturn, minimizing the suffering,
but it does nothing to fix the underlying problems,
and it creates imbalances which must be removed when the economy recovers.

It’s medicine. Powerful when used correctly. But like all sharp tools it cuts both ways. Confusing first aid (emergency medicine) with long-term treatment can produce serious errors.

(2) It was easy. It’s always easy to get hooked

Our leaders are competent and smart. But history is largely a tale of smart people leading nations into trouble. In tough times leaders face harsh choices. Sometimes they take a high-risk path, confident that they can manage it. Sometimes they’re successful. Sometimes the results just feel good for a time.

From “Why Heroin is Better than Everything Else“:

Many people who experiment with heroin are underwhelmed at first (not including IV usage, but few experimenters IV first time). They just feel good, chill, happy, They feel like this spooky drug ‘heroin’ hasn’t delivered. They are mellow. They think obviously it has all been a lie.

Heroin isn’t spooky. It’s not addictive like everyone tells them. It doesn’t make you do stupid s**t or stay up all day and hallucinate like amphetamines or coke. It doesn’t empty your serotonin like MDMA or give you a hangover like alcohol. People tend to think what a nice drug. The next day they wake up and everything is normal. No headache or sh***y feeling. Just a slight afterglow of that nice feeling. … Then next weekend comes … I should get more for the whole weekend. I will use Heroin on the weekends now

(3) About government stimulus programs

The curative properties of government stimulus results from the brief duration of most recessions. They last a year or so, with government programs usually enacted in the middle — near or even after the low, so signs of recovery soon appear. When the private sector has underlying problems so severe they prevent normal recovery — as in the Great Depression, and Japan since 1989 — then stimulus programs are seen in their true light — useful palliatives but not magic bullets.

Unfortunately, measures to mitigate the pain contain a hidden risk, as this down cycle shows. A recession provides a unique opportunity to take important public policy measures, such as tax changes, regulatory reforms, and construction of valuable infrastructure projects. The US has wasted this opportunity, probably because the rapid and strong policy response so muted the pain (or its recognition by our leaders) that insufficient political pressure existed to overcome the inevitable inertia.

What about the beneficiaries of fiscal and monetary policy? We have to pay for fiscal stimulus, and the rich know they’ll get the bill eventually. So they work to end the spending once the crisis fades — far too soon in this cycle, when we could have borrowed cheaply to put many unemployed to work rebuilding America’s infrastructure.

Monetary policy, however, has a different calculus. No politically powerful victims (elderly savers lack sufficient punch). It feels good, and appears to cost nothing. It benefits the nation by boosting the value of their assets. Monetary stimulus is the best public policy.

Users sometimes find they do better work on heroin. Instead of being sad, grumpy or depressed, I am happy. Mellow. Content. I woke up at 5:30AM, it’s raining and dark. I’m commuting in traffic. I would have had a headache, I would have been miserable, I would have wondered how my life took me to this point. But now life is beautiful. The rain drops are just falling and in each one I see the reflection of every persons life around me. Humanity is beautiful. In this still frame shot of traffic on this crowded bus I just found love and peace.

Heroin is a wonder drug. Heroin is better than everything else.

(4) About the winners

Monetary policy works wonders. Not on the economy, after the zero-interest rate policy (ZIRP) has taken effect (see this Fed paper for details). Not for the savers earning a pittance on their nest eggs. it sends asset prices soaring, most importantly stocks and real estate. Like a miracle.Their owners are geniuses. Those using leverage are, entrepreneurs. Those using the most leverage are masters of the universe.

In America assets are mostly owned by the wealthy (the top 10% own 80% of stocks). The industries trading these assets also benefit, also largely owned by the wealthy. They have the political power in America, and use it to keep the monetary juice flowing.

Candidates for high office get vetted on their willingness to continue the monetary juice. Those like Larry Summers, with a combination of sufficient smarts and personal strength to take necessary public policy action that ends the fun, are blackballed. Those like Janet Yellen, smart and proven complaisant, get the red carpet rolled out for them.

(5) Why end the fun?

Heroin builds up a tolerance fast. Heroin starts to cost more money. I need heroin to feel normal. I don’t love anymore. Now I’m sick. …

QE1 was small. QE2 was big. QE3 was “unconventional”. Now we’re hooked, and the rationalizations begin. We are strong. We feel exceptional. We can list reasons that we will dominate the world. There are no ill effects to QE (don’t worry about the mispricing of capital) until either the currency crashes or inflation spikes up — and that will tell us it’s time to stop. And then we’ll stop, rapidly and easily.

Of course most of us see the madness of our policies. But we’re cogs, passive subjects of New America. We saw the madness of the tech boom, and most of us cheered — swept along by the tides of delusion. We saw the real estate boom, but enjoyed our paper profits too much to demand reforms. Now we have the third bubble.

It’s these things that show a people’s mettle. The Constitution refers to “Nature’s God”. She has a balance, and occasionally weighs our worth. Sooner or later we will see the need to take action. The Fed meets in October and December, two more opportunities for hard wisdom. After that we might have action forced upon us by events.

No this isn’t working, I need to quit.

Then will come the difficult days of withdrawal.

(6) Pictures of the US money supply

(a) The Fed’s Balance Sheet, from the St Louis Fed weekly report, QE1 ran from November 2008 to June 2010. QE2 from November 2010 June 2011, QE3 began September 2012.