January 21, 2009

Economic Crapshoot Ahead

Finding wisdom on the question of economic stimulus may be Washington’s most important task in generations – short of major war decisions. President Barack Obama currently is proposing to spend about $850 billion over two years that he asserts is intended to stimulate the economy and thereby add 3-4 million jobs that otherwise would not exist.

It is generally expected that Obama is lowballing it and that after Congress is finished, the level will be closer to $1.2 trillion. Without such efforts, it is asserted, we would face something on the dimensions of the Great Depression (during which America endured up to 24 percent unemployment and up to 13 percent contraction of gross domestic product in a single year). With the stimulus and other legislative and executive actions, people close to Obama hope that unemployment would top out at less than 10 percent and GDP contraction at about 5 percent.

Rarely has so much hung on contested economic theories and ambiguous historical references. The first question is whether fiscal stimulus can ameliorate an economic contraction. Interestingly, Obama’s chief economist, Christina Romer, according to The New York Times, “concluded in research she helped write in 1994 that interest-rate policy is the most powerful force in economic recoveries and that fiscal stimulus generally acts too slowly to be of much help in pulling the economy out of recessions.”

Although she now supports Obama’s stimulus, many economists fear that by the time a stimulus comes online, the economy already will be recovering and all the stimulus will do is induce inflation. With trillion-dollar deficits and huge expansions of the money supply by the Federal Reserve, the prospect of double-digit or worse inflation in a year or two is a real danger to consider.

On the other hand, even many important conservative, free market economists – including some of former President Ronald Reagan’s top economists – believe we do need a very big fiscal stimulus a la what we had in the 1930s and ‘40s. And here is where it gets even more confounding. Maybe a trillion-dollar deficit is too small. Most economic historians believe that the Great Depression did not end until World War II because only then was the deficit spending big enough to fully replace the lack of private-sector economic activity. FDR was afraid of big deficits and didn’t spend enough to end the Depression sooner.

If that theory is right, consider that during WWII, the deficit as a percentage of GDP was: 1943 – 30 percent; 1944 – 23 percent; 1945 – 22 percent. A trillion-dollar deficit in 2009 would be only 8.3 percent of the GDP, although it would be bigger than the previous biggest deficit since WWII – 6 percent in 1983.

So, if the Depression-WWII theory is to be followed, then next year’s deficit should not be a paltry $1 trillion, but rather about $2.5 trillion (in order to be about the same percent of the GDP as the WWII deficits were). At a mere trillion, we may be spending enough to badly inflate the currency without spending enough to lift the economy.

Of course, economic historians point out that 2009 is vastly different economically from 1943. Back then, we had almost a command wartime economy. There were few consumer products available; our economy was much more self-contained than our globalized economy and financial system is today; we had rationing of food, gasoline and other products; the government was spending the money directly to build and run war material factories; and 16 million people were in the military – mostly abroad.

So how literally do we want to copy the methods of the past to cure today’s problem?

If we agree to spend trillions of deficit dollars in the next two years, can our political system spend it for the purpose of stimulus, or will it waste hundreds of billions of dollars on pet projects that do not maximize the stimulating potential of government deficit dollars? It is hard not to giggle at that question. There is already abundant evidence of members of Congress pushing for projects that will yield little stimulus but may yield local votes for them in two years. And from what I have heard off the record, team Obama also is checking around to see what politically popular projects they might back around the country.

Any experienced political observer must conclude that if we go ahead and spend the trillions of deficit dollars, inevitably a significant percentage of those dollars will get us very few jobs or economic activity per buck. If the spending will bring a prompt recovery, it may be worth the corrupt waste of much money. But will it work, even then?

We are about to roll the dice on the biggest crapshoot in the economic history of humanity. Will seven come 11? Or will it be snake eyes for our economic future?

COPYRIGHT 2009 CREATORS SYNDICATE INC. 

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