Tuesday, February 17, 2009

Streets of fire

Today President Obama signed a $787 bilion economic stimulus package. Even though there was a great deal of debate, I think it was a foregone conclusion that we would have had some type of stimulus package. The question is, will it work? Or maybe the better question is, how will we define whether it works?

One of three things can happen. Either the package will help the overall economy, the economy will get worse, or we will not see any affect on the economy, at all. None of these are really fair. It could help the economy by not letting it get as bad as it could have gotten. I think it will be tough to gauge. As for the job estimates, I have seen everything from 3- 4 million jobs saved or generated from the administration to 1-3 million from the CBO. Again, I am not sure we will ever get a good estimate, but I am willing to wait and see.

I think we can still subject it to some questions and talk about what might or might not happen, with some certainty. We know that it is a mixture of tax cuts and spending. We know that the tax cuts will mostly go to working middle and lower class citizens. We know that most of the spending will go to extending unemployment benefits and health insurance benefits. Here are the specifics, to the best of my knowledge:

$48 billion for highway, bridge and mass transportation
$282 billion in tax cuts
$70 billion for AMT relief
$54 billion for education, of which about $14 billion will go towards modernization
$70 billion for energy efficency programs and tax credits, including about $22 billion for programs that might be considered job creating/saving
Various home buying credits, SSI payments, new car incentive, working families tax credit

So what exactly will be stimulated? Generally speaking, in a recession, increases in government spending will improve the economy. However, we should not make the mistake of thinking that any kind of government spending is good for the economy. If you look at what can possibly create or preserve jobs, I only see about $86 billion in spending. I am skeptical that $86 billion in spending over the next two years will have as much of an impact on the economy or the job market, as everyone hopes. in a $14 trillion economy, that is just not that much.

The rest is tax cuts, and I am not sure they provide the right incentives to help the economy. Rather than lovering tax rates, these tax breaks give one time payments to various groups of people. I am not sure this one-time event will have the desired effect. Time will tell. When you talk about extending unemployment and health benefits, that helps those families put food on the table and keep a roof over their heads, but essentially you are robbing Peter to pay Paul. Those who pay taxes are supporting those who are getting the benefits. the other difficulty with tax cuts and programs like this is that they can become politically popular, and, thus, difficult to dismantle. To his credit, President Obama has addressed this saying that when the economy recovers, we will have to get back to good economic policy, spend wisely, make the tough choices, etc. However, as last Friday's USA TODAY noted, "The stimulus increases spending on a wide array of politically popular social programs, including health care, for the unemployed, college grants, Head Start for disadvantaged kids, biomedical research, law enforcement funding, and so on. These increases are supposed to be only for a limited period, generally this year and next. In budget-speak, however, they raise the 'baseline' amounts forthese programs. any attempt to bring the new baseline amounts down to pre-stimulus levels will undoubtedly be greeted with howls about 'cuts' that would hurt the poor, the infirm, students, researchers and police." In addition, what kind of precedent is being set here. It does not take an astrologer to tell you that more and more we will hear cries of "bail me out" as a result of all the spending, beginning with Bear-Sterns, last year, and now this newest spending package. (I'm not sure that was a sentence, but you get the idea)

Without much in the way of job-creating/saving spending, what happens when things get worse. The discount rate is basically nothing now, so monetary policy cannot be used. The Fed has said it has other means to aid the economy, but they asll involve gauranteeing more bad loans, essentially more of the same. Let's not forget that the root cause of the economic problems we find ourselves in now are the toxic loans on banks balance sheets, now. While I'll touch more on this in my next installment, my position has not changed. As long as the banks are allowed to escape their poor lending decisions, without taking the proper losses, we will continue to suffer, economically. Even when the economy improves, and it will improve sooner or later, those bad loans will act as a drag on our economy. The markets need to have confidence in their freedom to set prices, reward winners and say good-bye (notice I did not say 'punish') losers. That is why whenever a plan has been announced, the markets do not respond in a positive manner. Markets reflect what investors think will happen in the future. We should not make policy to plerase the markets, but that does not mean we should ignore them. In this case they are saying that they do not have any confidence in the stimulus package. And that is a significant statement considering that everyone has been waiting for this since President Obama was elected.

Harvard economist Robert Barro said in last weeks WSJ, "This is probably the worst bill that has been put forth since the 1930s. I don't know what to say. I mean it's wasting a tremendous amount of money. It has some simplistic theory that I don't think will work, so I don't think the expenditure stuff is going to have the intended effect. I don't think it will expand the economy. And the tax cutting isn't really geared towards incentives. It's not really geared to lowering tax rates; It's more aloing the lines of throwing money at people. On both sides I think its garbage. So in terms of balance between the two it doesn't really matter that much."

To his credit, President Obama is providing leadership and continues to tell us that we have a long road ahead of us, as a nation. He inherited a dismal economy that was never lead anywhere except to the edge of a cliff. I wish he had taken a different approach, but, like I have said before, we must keep in mind that both Republicans and Democrats had the same philosophy to this problem. The spending may have been a little different, but, overall, the approach and the effects would have been the same.

With all the question marks, we know one thing: the federal debt will soon stand at $10.7 trillion dollars. President Obama stated that when the economy begins moving again, we will need to start the process of "taming our expolding deficits." This begs a final qeustion for today, what if the economy does not start moving in time to prevent calls for more stimulus. We have seen that when the government gets out the checkbook a line forms of people who try to get what they can.

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