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Monday, January 19, 2009

Obama's Stimulus Package is Bound to Fail

While some people will say that no one knows how it will affect the economy, there are in fact only so possibilities and each every one of them leads to financial doom. Let's examine the potential outcomes and see.

1)It works beyond his wildest imagination.

In early 2010, we are in the middle of a full fledged recovery. All of the stimulus in the package worked beyond his wildest dreams. The unemployment is between 5-6% and headed down. GDP has recovered and is growing again. Most economic indicators are pointing to recovery and expansion.

In such a case, what we will have done is run up a deficit well over $1 trillion just as the economy begins to hum. The massive inflationary effects will begin to take hold. The ONLY reason we haven't felt the effects of massive inflation because of out of control borrowing is because the economy is so weak. Yet, deficits of $1 trillion and more aren't merely inflationary but extremely inflationary. If you combine that with an economy that is growing, you are bound to see some serious inflation.

Now, in such a scenario, inflation wouldn't have to be all that large to be deadly. Let's suppose inflation grows at just over 3.5%. While that is mildly inflationary, that's certainly not some massive number. Now, we would have inflation that's more than while unemployment is still higher than we would like. We would be stuck in stagflation.

As such, by countering one, the other would get worse. For example, Obama could use the inflation as an excuse for raising taxes on those making over $250,000. By doing so, he would be raising taxes into the teeth of the recovery. Such a move would stunt the recovery, halt economic growth, and at best unemployment would hold stead at just over 6% for the indefinite future. At worst, it would climb back up. Either way, he would be stuck managing a stagnant economy with high unemployment.

2) Another possibility is that the stimulus does little to stimulate and unemployment would continue going up. Let's say that unemployment is near 10% a year from now. He would likely be forced to spend even more money for more stimulus. There would be calls from himself and his party that the initial stimulus wasn't big enough. Now, a year from now, we would spend even more and get into even larger deficits.

If a recovery resulted from that second stimulus, the inflationary effects would be even greater. Imagine the inflationary effects of $1 trillion in new debt. Now, double it and that is the scenario you have. If we finally got to below 6% unemployment, we would get there with inflation at 4% and more. Once again, we would have stagflation only it would be even worse than in the original example.

3) Another possibility is that the economy recovers only mildly. Let's say in the next year, the unemployment goes up for a while and then begins to come down again. By early next year, it is about where it is now. Yet, the mild recovery will also push inflation upward if only marginally.

Of course, with unemployment still above 7.2%, it won't take much inflation for it to cause economic havoc. Let's say that inflation is merely pushing 3%. In such a case, we are stuck again. Anymore recovery and inflation becomes a problem. Yet, stunting the recovery when unemployment is still at 7% plus would put us right into a depression.

Once again, Obama could use the ire of inflation as an excuse to raise taxes on those making $250,000 and more. Yet, such a move would at best freeze the employment rate at what it was at the time. In this scenario, we would be looking at perpetual 7% plus inflation.

It's important to understand that the more the economy recovers, the more inflation becomes a problem. As such, if the economy were to make an unprecedented recovery to an unemployment rate of say 4.5%, the inflation rate would be something unheard of 5% and more. Interest rates would be at unprecedented levels. Mortgage rates would be well above 8%. People on savings and fixed income would get crushed.

As such, Obama would become a victim of his own success. The more the economy recovers the more inflation would set in responding to all of the inflationary pressure he has put on it. There is no way to get around this. You can't simply borrow with no end and not pay for the consequences at some point. The payment comes in the form of inflation as soon as the economy is recovering. The stronger the recovery the more inflation will follow. Yet, a weak recovery would only trigger even more borrowing. This would make the eventual inflation even worse.

At best, Obama's stimulus would causes us to go from a terribly weak economy to high inflation. At worst, we would enter a period of stagflation. Either way, there is no way for the economy to recover without causing some sort of other economic nightmare.

4 comments:

Anonymous said...

This is what I keep trying to explain to the Obama-philes at work, who just insist then that the only solution is for Obama to somehow then "fix all that too"...as if the president has all these levers and strings to pull to make all those little things like economic reality go away by regulating them out of existence. And not one of them is smart enough to understand that all this has been tried before....

God help us.

Naftali2 said...

Hi Mike,

There is a possibility that inflation won't be a factor. I say this because the 'pool of capital' has already been reduced by a staggering total, and the government simply printing money will restore the pool of capital to the previous rate.

There is also the possibility of some technological advance that changes the economy, such as personal computers and the internet did in the 80s and 90s.

I've said all along that energy development and energy technology is the way out of this mess and the gas discovery in Israel will certainly help, because the Israelis will not only mine their natural gas but also invent new technology to make the use and development easier to incorporate into society. They have always done a lot with few resources.

The problem with economics is that it limits itself to economics when history, science and technology, and random events also factor into the workings of any nation, now, global, the world.

So, I'm saying many things can unfold in the coming years, and if Obama does not have the right answers, then the Republicans need to have the right answers. And if no one knows what to do, then pray.

mike volpe said...

The pool of capital hasn't been reduced. It is sitting on the sidelines. It just isn't being used. That is a bunch of nonsense.

Look economics is ultimately all about logic. You can't simply print and borrow with no consequences. If there were no consequences, all governments would go deep in debt at all times. It's inflationary. Period. that's why you can't do it. Obama is doing it in spades and he's being rooted on. As such, if his stimulus works, it will set off major inflation. Period. That's how it works.

Rev. Bob said...

Hyper inflatin is the only way to get rid of our massive debt. While hyper inflation raises prices and wages, it doe nothing to increase contractual debt. Yur mortage and the debt of society, ie govt on all levels, remains the same.