There are conflicting opinions about whether the economy can recover without heavy doses of government intervention.
Arguments for the "stimulus" include allusions to another depression without it.
I will argue the opposite - that we can't have a depression without the "stimulus".
The affects of the current portion of the economic crisis have produced two unbelievable circumstances: the Federal deficit will exceed $1.
2 trillion and the Federal Reserve has increased its balance sheet by around the same amount.
Those two issues alone are enough to create severe financial burdens.
What will happen if another half trillion or trillion dollars is added to the load? The Treasury department and the Federal Reserve can get away with those astronomical liabilities because there is a vast pool of capital content to lend money for little return, in exchange for a higher probability of being paid back.
As the banking crisis progressed commercial paper lenders (money market fund investors) became increasingly wary of financial institutions.
When the panic hit in late September and early October that money was pulled out of banks and brokers, and used to purchase US Treasuries (more than $220 billion).
Because the demand for US government debt was high during the crisis, the Fed and the Treasury have not had any trouble financing the current portion of the $700 billion bailout.
But the crisis will not last forever.
A recovery will happen with or without the stimulus - corporate profitability dictates marginal economic activity, not some ephemeral output calculation upon which the "stimulus" seems to rest (empirical evidence is overwhelmingly against any "stimulus" having net-beneficial effects).
When the recovery does begin confidence will return to financial intermediation.
The pool of capital that is now being lent to the federal government at extremely low rates will shift back to commercial paper and common stocks.
The relevant question at that point will be, "who will the government borrow from?" Even during the expansion of the middle part of this decade government deficits were financed not from Americans but from foreign governments.
As the United States imported more than it exported the amount of dollars flowing outside the country increased dramatically (known as the current account deficit).
Those dollars found themselves in the hands of foreign governments who used them to purchase dollar-denominated debt assets, or, in short, they financed our purchases of imports by lending our government money.
That process works well when we are buying their merchandise.
But, as we have seen this week, the global crisis is hitting everyone hard.
Japanese exports to the United States fell by 35%! The South Korean economy contracted by 5.
6% in the fourth quarter of 2008, mainly on weakness in exports.
Even the Chinese economy has slowed remarkably, again on the vulnerable export segment.
If we are not buying their goods, they cannot buy our debt.
Who will buy the huge expansion in federal debt? Will American citizens come rushing to the aid of the government? Not likely.
Without foreign intervention it is very hard to see how massive new borrowing can take place.
In fact, the Chairman of the Federal Reserve may have even signaled his own worries about that possibility.
During a speech in early December to the Austin, Texas, Chamber of Commerce, Mr.
Bernanke indicated that the Fed might be willing to buy long-term government agency debt, and even long-term US Treasuries.
In the context of the housing bubble buying agency debt makes sense to help move mortgage rates lower, trying to stimulate demand (the first part worked, rates did drop, but the second part is not even close to working).
But why would he indicate a willingness to force long-term US Treasuries rates down? The short answer is an increase in money supply.
By taking bond assets off the hands of investors the Fed is increasing the amount of cash in the economy.
That would make some sense absent the $1.
3 trillion increase in Fed liabilities.
But the banking system is already awash in Federal Reserve notes and credits.
I suspect that Mr.
Bernanke is preparing the marketplace for the possibility that there may not be enough buyers of government debt.
If that does occur the Fed will have to step in and be the buyer of last resort (in addition to being the lender of last resort).
As the burden of the "stimulus" debt is added to the already burdensome deficit the imbalance between debt supply and demand will increase.
If overseas governments have not recovered sufficiently to increase their demand for it (with a weak recovery it is very hard to see that happening), and if American investors do not abandon their desire for higher returns, the imbalance in favor of the supply of debt will be so great as to force interest rates higher across the board.
The competition for funds is increasing as every economy in the world is trying to borrow their way out of this mess.
At that point the Fed will have a choice: do nothing and risk a collapse in credit demand and a renewed banking crisis, or intervene by printing money to purchase longer-term treasuries.
It would be a no-win situation.
If rates skyrocket as a result of the debt supply imbalance, which would have to happen absent any trillion-dollar lenders, the economy would collapse, as would the banking system.
But if the Fed prints trillions of new dollars to pay for the deficits, rates would also go through the roof.
Remember that interest rates at the most fundamental level are tied to inflation, and a huge increase in money stock would lead to a huge increase in inflation.
Again, an economic collapse.
As the debate for "stimulus" proceeds, there is no discussion about where the money will come from.
It almost seems as a given that someone, somewhere will loan the government money.
After all, we have had deficits for decades without any discernible deleterious affects.
But we have never tried to borrow $2 trillion in a very short time.
The only reason we have been able to up to this point is panic - and that nearly destroyed the banking system.
The only way to increase the capital base for government borrowing is by printing money, or by causing another panic.
Both choices lead to the same place - depression.
For those advocating "stimulus", be careful what you wish for.
Arguments for the "stimulus" include allusions to another depression without it.
I will argue the opposite - that we can't have a depression without the "stimulus".
The affects of the current portion of the economic crisis have produced two unbelievable circumstances: the Federal deficit will exceed $1.
2 trillion and the Federal Reserve has increased its balance sheet by around the same amount.
Those two issues alone are enough to create severe financial burdens.
What will happen if another half trillion or trillion dollars is added to the load? The Treasury department and the Federal Reserve can get away with those astronomical liabilities because there is a vast pool of capital content to lend money for little return, in exchange for a higher probability of being paid back.
As the banking crisis progressed commercial paper lenders (money market fund investors) became increasingly wary of financial institutions.
When the panic hit in late September and early October that money was pulled out of banks and brokers, and used to purchase US Treasuries (more than $220 billion).
Because the demand for US government debt was high during the crisis, the Fed and the Treasury have not had any trouble financing the current portion of the $700 billion bailout.
But the crisis will not last forever.
A recovery will happen with or without the stimulus - corporate profitability dictates marginal economic activity, not some ephemeral output calculation upon which the "stimulus" seems to rest (empirical evidence is overwhelmingly against any "stimulus" having net-beneficial effects).
When the recovery does begin confidence will return to financial intermediation.
The pool of capital that is now being lent to the federal government at extremely low rates will shift back to commercial paper and common stocks.
The relevant question at that point will be, "who will the government borrow from?" Even during the expansion of the middle part of this decade government deficits were financed not from Americans but from foreign governments.
As the United States imported more than it exported the amount of dollars flowing outside the country increased dramatically (known as the current account deficit).
Those dollars found themselves in the hands of foreign governments who used them to purchase dollar-denominated debt assets, or, in short, they financed our purchases of imports by lending our government money.
That process works well when we are buying their merchandise.
But, as we have seen this week, the global crisis is hitting everyone hard.
Japanese exports to the United States fell by 35%! The South Korean economy contracted by 5.
6% in the fourth quarter of 2008, mainly on weakness in exports.
Even the Chinese economy has slowed remarkably, again on the vulnerable export segment.
If we are not buying their goods, they cannot buy our debt.
Who will buy the huge expansion in federal debt? Will American citizens come rushing to the aid of the government? Not likely.
Without foreign intervention it is very hard to see how massive new borrowing can take place.
In fact, the Chairman of the Federal Reserve may have even signaled his own worries about that possibility.
During a speech in early December to the Austin, Texas, Chamber of Commerce, Mr.
Bernanke indicated that the Fed might be willing to buy long-term government agency debt, and even long-term US Treasuries.
In the context of the housing bubble buying agency debt makes sense to help move mortgage rates lower, trying to stimulate demand (the first part worked, rates did drop, but the second part is not even close to working).
But why would he indicate a willingness to force long-term US Treasuries rates down? The short answer is an increase in money supply.
By taking bond assets off the hands of investors the Fed is increasing the amount of cash in the economy.
That would make some sense absent the $1.
3 trillion increase in Fed liabilities.
But the banking system is already awash in Federal Reserve notes and credits.
I suspect that Mr.
Bernanke is preparing the marketplace for the possibility that there may not be enough buyers of government debt.
If that does occur the Fed will have to step in and be the buyer of last resort (in addition to being the lender of last resort).
As the burden of the "stimulus" debt is added to the already burdensome deficit the imbalance between debt supply and demand will increase.
If overseas governments have not recovered sufficiently to increase their demand for it (with a weak recovery it is very hard to see that happening), and if American investors do not abandon their desire for higher returns, the imbalance in favor of the supply of debt will be so great as to force interest rates higher across the board.
The competition for funds is increasing as every economy in the world is trying to borrow their way out of this mess.
At that point the Fed will have a choice: do nothing and risk a collapse in credit demand and a renewed banking crisis, or intervene by printing money to purchase longer-term treasuries.
It would be a no-win situation.
If rates skyrocket as a result of the debt supply imbalance, which would have to happen absent any trillion-dollar lenders, the economy would collapse, as would the banking system.
But if the Fed prints trillions of new dollars to pay for the deficits, rates would also go through the roof.
Remember that interest rates at the most fundamental level are tied to inflation, and a huge increase in money stock would lead to a huge increase in inflation.
Again, an economic collapse.
As the debate for "stimulus" proceeds, there is no discussion about where the money will come from.
It almost seems as a given that someone, somewhere will loan the government money.
After all, we have had deficits for decades without any discernible deleterious affects.
But we have never tried to borrow $2 trillion in a very short time.
The only reason we have been able to up to this point is panic - and that nearly destroyed the banking system.
The only way to increase the capital base for government borrowing is by printing money, or by causing another panic.
Both choices lead to the same place - depression.
For those advocating "stimulus", be careful what you wish for.
Source...