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Wednesday, November 12, 2008

Global Stagflation Step IV

Today, the Obama campaign floated the idea of increasing the stimulus package.

President-elect Barack Obama is hearing from private sector economists, and some members of his economic advisory team that Congress should consider -- and he should sign into law in January -- a far broader stimulus package than anyone has publicly discussed to date.

Instead of $300 billion dollars, which has been the upper limit, they are now talking about $500 billion, which is 3 to 4 percent of GDP.

These advisers are looking at analysis that says next year unemployment could top eight percent, private sector spending could drop six percent of GDP, and the Federal Reserve is basically out of room to do anything more with monetary policy.

The Obama campaign is talking about making this stimulus in the form of government spending on infrastructure like roads, green jobs, as well as tax credits, and unemployment extensions. If you are a student of history, this plan should sound familiar because it is right out of the playbook of the New Deal. FDR attempted to jump start the economy by massive new government spending. The end result then was that in 1940, eight years after taking office, the unemployment rate continued to be north of 10%. In other words, the economic reality of the New Deal was that it was a collosal failure. It was only our entrance into WWII that ultimately ended the Great Depression.

Now, President Elect Obama will attempt to impose his own New Deal. Only this time, the dynamic is a bit different. We already are about to borrow $700 Billion for the bailout. Another $500 Billion will add over $1 trillion in new government spending before President Elect Obama even attempts to implement any of his goals: universal health care, educational improvements, etc. Our country borrows money through U.S. Treasury Bonds. This massive new borrowing will put signficant downward pressure on the yield for bonds, and inverse for their interest rates.

All of this new borrowing is ultimately inflationary. Furthermore, there is absolutely no evidence that any of it will actually move us out of the recession. The previous stimulus package, this past summer, was an utter failure. The last time a President attempted to get an economy out of a recession through massive new government initiatives that was a failure.

When an economy is facing high unemployment at the same time it is facing high inflation, that is called stagflation. The world economy almost always takes its cues from the one here. If we are facing the nightmare scenario of high unemployment at the same time here in the U.S., it won't be long before the rest of the world follows. If the next administration insists on highly inflationary policies which are dubious at best in stemming the recession, that is likely exactly where we will soon be.

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