The Stimulus Of Last Resort

I'm quite sure most Americans are unaware of the Big Trouble that appears to be brewing on the economic horizon. They're too busy getting taken to the cleaners by Steve Jobs waiting in line to buy Apple gadgets. I partly addressed the situation over the weekend in Crank Up The Money Printer! But I suspect many DOTE readers didn't see it—traffic falls on the weekends—so I will return to that subject today. Please read Saturday's post if you haven't already done so. (It's short.)

The economic situation is getting very serious, folks. Is 2010 akin to 1931? That's the question on the table.

As is often the case, we must turn to the British financial press to get a sense of a coming emergency. In the Telegraph, Ambrose Evans-Pritchard reports that RBS has told clients to prepare for 'monster' money-printing by the Federal Reserve—

As recovery starts to stall in the US and Europe with echoes of mid-1931, bond experts are once again dusting off a speech by Ben Bernanke given eight years ago as a freshman governor at the Federal Reserve.

Entitled Deflation: Making Sure It Doesn’t Happen Here, it is a warfare manual for defeating economic slumps by use of extreme monetary stimulus once interest rates have dropped to zero, and implicitly once governments have spent themselves to near bankruptcy.

The speech is best known for its irreverent one-liner: "The US government has a technology, called a printing press, that allows it to produce as many US dollars as it wishes at essentially no cost."

Echos of 1931. Think about that. If 2010 is really analogous to 1931, all bets are off. Although Evans-Pritchard's tone is mostly neutral in this article, neo-Keynesian Martin Wolf of the Financial Times has no qualms about making his position clear. I quote from Why it is right for central banks to keep printing—

In current circumstances, the belief that a concerted fiscal tightening across the developed world would prove expansionary is, to put it mildly, optimistic. At this stage, I will inevitably be asked: what is the alternative? If these huge deficits continue, markets will take fright, interest rates will jump and the debt dynamics will become truly awful.

I have two responses to this.

The first, one I made a week ago, is that the de-leveraging cycle is generating huge private sector financial surpluses across the developed world. Unless we expect a shift into aggregate external surpluses (and corresponding deficits in the emerging world), these surpluses must now to be invested in government liabilities. This helps explain why yields on the bonds of safer governments remain so low.

The second response is that if governments need to run deficits, to support demand at a time of private sector weakness, they can always borrow from central banks. Yes, this is “printing money”. It is also an insanely radical policy recommended by no less insane a radical than Milton Friedman, back in 1948. His view was that the government could expand the money supply during recessions and contract it in the subsequent booms. A country with a fiat currency and a floating currency could, thus, stabilize the economy without destabilizing credit markets. The neat thing about this proposal is that one does not have to decide whether fiscal policy or monetary policy is doing the heavy lifting: they are two sides of one coin.

Let's look at the cold, hard facts. First, there will be no more fiscal stimulus of the U.S. economy now and for the foreseeable future (out to at least 2013). This is an election year, and most voters have been successfully indoctrinated with the idea that Government Spending Is Bad. In fact, our huge deficits are bad, but not for the reasons many voters believe. Republicans will likely take back the House of Representatives. Our dysfunctional two-party politics is about to get worse, assuming that's possible. An unbreakable deadlock in the Congress is a dead certainty from now until after the presidential election in November, 2012.

Our Central Bank acts independently of the Congress, which means Ben Bernanke can apply additional Quantitative Easing (QE) without consulting that August Institution. The Federal Reserve chief requires only the approval of the bank's board of governors. Martin Wolf believes it doesn't matter whether fiscal policy or monetary stimulus is applied, for they are but two sides of the same coin.

More money printing by our Central Bank is literally the stimulus of last resort. If that measure fails to achieve an economic lift-off—why would we expect it to succeed?—we will have officially run out of options, we'll have shot our wad. As Don Meredith used to sing on Monday Night Football after the game had been decided, turn out the lights, the party's over.

OK, think about 1931 again. That was the beginning of the worst decade by far the United States ever had. In 2010, commentators (including me) talk about a "double dip" in the economy, which means (technically) a contracting GDP number measured in trillions of dollars. Although I've been talking about that eventuality since I started this blog in January, when few people took the possibility seriously, it is now commonplace to read about the coming "slowdown" in the 2nd half of this year. Calculated Risk has been keeping track of all the reasons he expects growth to taper off—

But [State spending cutbacks] are just one drag on the economy. I've been forecasting a 2nd half slowdown in GDP growth based on:

1) less Federal stimulus spending in the 2nd half of 2010. The decline in stimulus will probably be a drag of about 0.5% on GDP growth by Q4.

2) the end of the inventory correction. The inventory adjustment contributed 3.79 percentage points in Q4 2009 of the 5.6% annualized growth rate, and 1.88 percentage points of the 2.7% GDP growth (annualized) in Q1 2010. This will probably fall close to zero in the 2nd half (maybe even slightly negative).

3) more household saving leading to slower growth in personal consumption expenditures. The personal saving rate increased to 4.0% in May, and will probably rise further in the 2nd half.

4) another downturn in housing (lower prices, less residential investment). This might subtract 0.25 to 0.5 percentage points from growth in the 2nd half.

5) slowdown and financial issues in Europe and a slowdown in China,

6) and the cutbacks at the state and local level. According the Mark Zandi, this will subtract about 0.25% from GDP growth.

As I've noted before, a quarter point here, and half point there ... and pretty soon you have some real drag.

Some "real drag" indeed! Calculated Risk forgot to include the lack of improvement in unemployment claims. We're having a "jobless" non-recovery. Is what's coming just another recession? Or a Great Depression? Or some new kind of depression?

 
Our Future?

Americans continue to hit the snooze button, but it's time to wake up. Professor Krugman thinks we may be looking at a Long Depression, whatever that means—

We are now, I fear, in the early stages of a third depression. It will probably look more like the Long Depression than the much more severe Great Depression. But the cost — to the world economy and, above all, to the millions of lives blighted by the absence of jobs — will nonetheless be immense.

Everything Krugman says is politically motivated. He wants more stimulus, that's his agenda. I'm quite sure from previous remarks he's made that he would heartily approve of another expansion of the Fed's balance sheet. I myself don't think it will make any difference, I don't have an agenda. I expect another round of QE to fail.

What concerns me most about all this discussion is the very fact that we're having it. Unless all this talk is merely politically motivated hyperbole, we may really be up shit creek without a paddle for a long time to come. Why would British commentators have an American political agenda? I believe they think our situation is perilous.

Is 2010 really 1931?  I fear we're about to find out, and the news will not be good.

Comments

[Bill Mcdonald]

I agree with you our situation is as dire as the 1930's. And the average
person is sleepwalking, unaware they are about to go right over the parapet.

But what can the average person do, other than to try to save up money and
and supplies for the times to come? Their elected officials are all part of the plan, so to speak, and inaccessible without some real "palm greasing".

It really isn't looking good.

Btw, I have twice tried to sign up as a follower via type pad with no luck.

Bill Mcdonald

[Greg Pinelli]

Everyone is entitled to their opinion...usually I find Dave's worth the while..everyone is not entitled to their own set of facts. Quantitative easing works when two things are present...
First...Debt levels by borrowers allow further indebtedness...
Second...the Fed CAN later tighten without bringing the house down...
Neither of these prerequisites exist...Not only can the banks NOT shovel loans out the door..they are scared to death to even try.
A debt implosion is in the works..deflation is going to be a way of life. Jacking around the money supply might sound clever..but it's beyond working.

[agog]

"We expect that the US economy has entered a prolonged and steep decline that could reduce real GDP by 20 percent or more over the next several years with no immediate prospects for recovery."
Jim Rickards (p. 18 in pdf link at Jesse's Cafe Americain. It is a 42 page document and well worth the time.)

Also, it's "Wolf". I really don't understand why Martin Wolf is widely regarded as being "brilliant". Maybe it is in the same way Larry Summers is "brilliant". I suppose we are expected to shut up and defer to our betters. It has certainly worked well so far.

[jaggedben]

"Long Depression, whatever that means"

The Long Depression was the financial depression that began in the 1870s. Is 2010 akin to 1931, or to 1875?