Obama's Stimulus Conceit Spooks Markets
Think what you may of the so-called stimulus bill, either as an instrument of economic policy or sheer political accomplishment, those who have capital gave this signature accomplishment of the Obama administration the Bronx cheer. As the bill progressed towards certain passage, equity markets responded by posting their worst one-week declines since the week ending November 21st. Last week, the S&P 500 fell 4.8% while the Dow Jones Industrial Average ended the week at 7850 down 5.2% and its lowest close since its bear market low of 7552 on November 20th.
The fact that the stock market is hovering near its bear market lows is all the more remarkable given the improvements in the functioning of credit markets over the past 2 ½ months. Since November 21st, LIBOR has dropped to .45% from 1.45%, the TED (Treasury, Eurodollar) spread has dropped below 100 bp from 214 bp, the spreads on investment grade corporate bonds have fallen by more than 100 bp, and the spreads on high yield debt by about 350 bp. It would not be unreasonable to have expected the alleviation of the fear of massive defaults and a deflationary spiral represented by such an improvement in credit markets to be associated with a 20% relief rally off the lows, carrying the Dow Industrials to levels above 9000.
Why the vote of no confidence by equity markets in the massive spending package?
The answer can be found in the following excerpt from President Barack Obama’s opening statement at his February 9th press conference:
“It is absolutely true that we can't depend on government alone to create jobs or economic growth. That is and must be the role of the private sector. But at this particular moment, with the private sector so weakened by this recession, the federal government is the only entity left with the resources to jolt our economy back into life. It is only government that can break the vicious cycle where lost jobs lead to people spending less money which leads to even more layoffs. (emphasis added) And breaking that cycle is exactly what the plan that's moving through Congress is designed to do.”
There are two fundamental flaws in the President’s statement, and they are at the root of the problems with his economic policies. The first is simply this: Contrary to the President’s statement, within the context of the spending bill, the federal government has no resources. The government is not drawing on accumulated savings or retained profits to fund its spending. It is not selling any of its vast land holdings to provide resources to fund increased transfer payments to individuals or corporations.
What the federal government does have is an extraordinarily good credit rating which allows it to borrow trillions of dollars at extremely low interest rates. But, unlike a corporation, which garners the resources to retire that debt by satisfying customers, every dollar the government is spending now will be extracted from tax paying businesses and workers when the loans come due. What the President fails to see is that for every dollar spent, a dollar is being taken from the productive sector. And therefore, Federal spending, per se, offers no net economic stimulus. This bill – Keynesian demand side stimulus on steroids – follows the failed policies of the FDR administration, which prolonged the Depression in the 1930s, and the Japanese bout of deficit spending, which produced the lost decade of the1990s, only more so.
The second flaw is the conceit that President Obama and his advisors can break the vicious (downward) cycle by spending other people’s money. To the extent the federal money is spent on needed highways and bridges, or other items that serve the public at large and thereby reduces the barriers to doing business, there is at least the prospect of additional economic activity.
However, most of the money in this bill will be given to individuals and corporations in the form of tax rebates or transfer payments and will do nothing to reduce the barriers to commerce. Think of it as paying individuals or companies to dig holes and fill them up again, but skipping all of the make-work. The investments in green technology and the like may be desirable from a policy perspective. But, they most likely have a negative return – otherwise, private capital would be forthcoming. Investments with negative returns squander capital and reduce economic activity by taking it away from more productive job creating opportunities.
Unlike voluntary exchanges, which have the promise of making both supplier and buyer better off, thereby increasing the wealth of the community, most of the spending mandated by this bill will be one-sided, involuntary exchanges, where the person actually paying the bill (future tax payer) is made worse off, even as those special interest groups favored with the Federal largesse are made better off. As a consequence, this bill will weaken the private sector even as it extends the heavy hand of government and protects the special interests who rely on taxpayer funding. And, that will prolong, not shorten, this cycle of economic weakness.
These are the reasons why this bill has made our society poorer, not richer as President Obama seems to believe. This week’s decline in the stock market is but the first write-down of the country’s wealth in recognition of this brutal fact.