Deteriorating economic conditions have policymakers in
Washington, D.C. running around like Chicken Little. As a
result of the perceived falling of the sky, these same
policymakers are scrambling to come up with a fiscal
stimulus plan which, coupled with aggressive monetary
policy action by the Fed, is intended to stave off a
recession and calm jittery financial markets. Whilst these
initiatives are well-intentioned, these efforts are an
exercise in futility. There is little, if anything, that
can be done to stop the economic downturn that is in
progress and that is coming.
There is little doubt the current economic downturn was
caused by the deflating of the real estate bubble and the
mortgage crisis. This caused the banking system to clam up
and become more restrictive in lending. This began a chain
reaction which sent a systemic shock throughout the
economy, causing a credit crisis last summer that was
particularly disruptive to financial institutions whose
lending reluctance retarded liquidity and prompted some
degree of panic in equity markets and in corporate
boardrooms.
The Fed's actions in cutting the federal funds rate fifty
basis points along with other policy actions in August was
intended to build confidence and liquidity in the banking
system and, perhaps, shore up struggling equity markets
with a comforting "Bernanke put." Successive cuts along
with the seventy-five basis point cut on January 22, 2008
were aimed at shoring up markets amid mounting turmoil and
uncertainty over the magnitude and depth of the impact the
housing contraction and mortgage crisis would ultimately
have on the broader economy. Alas, the Fed's actions
cannot possibly solve the banking crisis. This was a
situation created by the banks that would only begin to be
relieved by massive write-downs and massive capital
infusions by foreign investors, namely Asians and Arabs,
totaling in excess of $21 billion. To be sure, there is
much more bloodletting to come at financial institutions
who provided too much credit when interest rates were low
with little apparent regard to attending risk of borrowers.
The Fed shares a part of the blame for keeping rates much
too low for much too long and in the process allowing the
real estate bubble to inflate precipitously. The magnitude
of this may ultimately be over $100 billion as derivatives
are revalued in the process to reflect current fundamentals
and counterparty risks are reassessed. And there is more
revaluation to come in the real estate markets as prices
adjust to reflect true fundamentals. This is all a painful
process that cannot be avoided forever.
In addition to monetary policy action, policymakers now
want to give taxpayers rebate cheques ranging from $300 to
$1600 in hopes that these rebates will prompt consumers to
continue spending and, thus, in the process revive the
lagging economy. There is a problem with this. The
federal government does not have this money to give away
right now; we simply can't afford it. This will likely be
funded through debt issuance. In all likelihood, either
Asian or Arab investors will purchase this debt. Now we
are in even more hock to these nations. And assuming
consumers spend the money on goods produced in these
foreign countries, the investors get their original money
back! This hardly makes good sense. In addition, this
fiscal stimulus does not address the mortgage crisis or
rising consumer debt levels. More attention should be
placed on financial responsibility and sound economic and
financial decision-making by the government and
individuals. To be sure, fiscal stimulus is good—but
only at the right time. Throwing money at a problem,
hoping it goes away, without addressing the fundamentals of
the problem is wasteful and counterproductive.
But this is not to suggest that policymakers remain idle
and twiddle their thumbs. To the contrary, action is
needed. Now is the time to reassess the challenges facing
the U.S. economy. A number of factors have resulted in the
economy becoming less competitive. Wages are higher than
in low cost countries. Manufacturing has moved overseas
for cheaper labour. Government spending has grown
dramatically. An entitlement program funding crisis looms.
Corporate taxes are among the highest in the world. The
tax code is complicated. Rather than the fiscal stimulus
proposed, policymakers should consider making President
Bush's tax cuts permanent, thereby eliminating a great and
looming uncertainty. The limits on tax deferred
contributions to retirement or 401k plans should be
increased as a means of increasing savings. The corporate
tax code should be reformed to make businesses domiciled
here more competitive so that U.S. companies don't move
offshore to avoid an onerous tax burden. The federal
government should reduce spending so that debt levels do
not increase significantly only to be further indebted to
foreigners. Congress should give the President the
line-item veto and restore pay-go rules as much as
possible, even though this is difficult in times of war.
Policymakers must begin the process of shifting to a
consumption tax as opposed to an income tax so that
taxation is equitable and so that even illegal aliens here
pay their fair share of the burden. The Federal Reserve
should increase the reserve requirements so that financial
institutions are more judicious when it comes to lending
depositors' money. This should help to avert another near
financial system collapse which could, the next time, have
more significant and more far reaching implications than
the current situation.
Undoubtedly, policymakers are doing what they deem best.
There is an old saying: The path to Hell is paved with
good intentions. The Fed's efforts to cut rates and the
policymakers' fiscal stimulus plan are aimed at helping
avoid a recession or at least soften the impact. No one
likes the thought of a recession, particularly in an
election year. Recessions are not a necessarily bad
phenomenon. All economies must undergo a cooling period.
The longer and higher the rate of expansion, the sharper
and deeper the cooling and contraction. These periods of
cooling are healthy for an economy. They temper excess and
help reign in moral hazards and excessive risk taking
associated with speculative activity. They serve as a
wake-up call to businesses, investors, and financial market
participants.
But rushing to make fiscal and monetary policy decisions
may only compound an already fragile situation. Now may be
the time to show fiscal and policy restraint, even in the
face of massive opposition. Fiscal stimulus and rate cuts
won't help. The banks and mortgage market participants
have to work this out for themselves. Shoring up their
balance sheets with equity injections and write-downs is
the only solution. Recent rate cuts or any further cuts
may well be mistimed and prompt higher inflation in a
period of lower growth. Sometimes it is best to bite the
bullet and let matters sort themselves out. Hopefully,
policymakers will show better financial decision making
skill than thus far. Going too far may open an economic
Pandora's box. Once that happens, the sky may really be
falling.
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Robert M. Clinger III & Sebastian G. Perey
Copyright 2007 Thinking Outside the Boxe
http://www.ThinkingOutsideTheBoxe.com
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