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Sunday, December 7, 2008

Massive New Public Works Projects Are Fraught With Dangers

Barack Obama has recently announced a bold plan for a public works project in order to jumpstart the economy.

President-elect Barack Obama said Saturday he wants to revive the economy through a job-creating public works plan on a scale unseen since the building program of the interstate highway system in the 1950s.

He offered no price estimate for the grand plan, how the money might be divided or the effect on the country's financial health at a time of burgeoning deficits.

The ideas were outlined in the weekly radio address the day after the government reported that employers cut 533,000 jobs in November, the most in 34 years. They are part of a vision for a massive economy recovery plan Obama wants Congress to pass and have waiting on his desk when he takes office Jan. 20.

The president-elect's address never once used the word "spend," relying instead on "invest" or "investments," and pledging wise stewardship of taxpayer money in upgrading roads and schools, and making public buildings more energy-efficient.

Now, while President Elect never used the word "spend", in fact, he is planning on jump starting the economy through massive new government spending. Such a plan is littered with all sorts of potential pitfalls. The first problem was correctly pointed out by Steve Chapman (in a piece I wound up criticizing)

Shoveling cash into various public programs sounds like a surefire way to boost total demand and thus juice the economy. But the money doesn't sprout from trees in Tim Geithner's backyard. Any funds it wants to spend, the government will have to borrow. The people who lend the money will no longer have it to spend. So the total amount of spending may not change much, if at all.

Timing is another glitch. Putting crews to work on roads and bridges doesn't happen overnight -- plans have to be approved, bids have to be solicited and contracts have to be signed. The Department of Transportation says that even with projects that are primed and ready, only one-fourth of the money gets spent in the first year. By the time an infrastructure program gets rolling, the downturn will almost certainly be shrinking in the rearview mirror.

Timing is a serious drawback to any fiscal stimulus. Tax cuts often take time to negotiate and pass and then they are usually only set for the year after at the earliest. A public works project has an even bigger timing problem. Presumably, President Elect Obama will ask for the money right away. That means the Treasury will borrow it soon afterwards. Who will be the debtors to such a transaction? Anyone that buys a U.S. Treasury bond will be. Now, U.S. Treasury bonds are bought by investors from all over the world from the Chinese to Saudis to all sorts of other folks. Of course, most of the Treasury bonds are bought internally. That means that right away, billions of Dollars will be taken out of the U.S. economy and put into these bonds. That isn't expansionary but contractionary and at the worst time.

Yet, the process of putting this money to work is long and arduous. First, the Treasury filters it to the states. Then, each individual Governor begins a long bidding process and then finally the money is put to work. It will likely be a year or more from the time it is borrowed until it is put to work. In the meantime, it will first contract the economy while money is taken out of circulation and into these bonds.

The more long term problem is that all of this borrowing is ultimately extremely inflationary. There is no action without consequence. The government is planning to throw caution to the wind and borrow with reckless abandon. The consequences of such borrowing seem to be totally trivial. They aren't. This is not merely inflationary but extremely inflationary. There is only so much deficit before it begins to affect the economy in a very bad way. We've already borrowed $700 billion for the financial bailout. Now, we are planning an extra $500 billion for this public works project. President Elect Obama can call it an "investment" all he wants but this "investment" will add substantially to our deficit, and it isn't clear just when it will be paid back.

Massive new borrowing has the exact same effect as simply printing money. That causes inflation. The nightmare scenario is that the economy contracts while all of this added borrowing causes inflation and we are back to 1979, when we had stagflation (recession and inflation simultaneously) Even if that doesn't happen, all of this inflationary spending will at some point have to be dealt with in terms of added inflation. The only reason that we aren't seeing inflation now is the economy's weakness doesn't allow it. Even, or maybe especially, if this massive public works project does stimulate the economy, that would mean there would no longer be a filter to all of this inflationary activity. As such, the massive new deficit will almost certainly lead to a situation where the strengthening economy will immediately be followed by a period of hyper inflation. Fixing one problem by creating another is no way to manage the economy.

The last problem is that many of the states are corrupt. Here in Illinois all of this highway money will likely wind up with friends and political power players. Dropping hundreds of billions of Dollars into the laps of corrupt politician to do with essentially as they please is a sure fire way to create a massive amount of new corruption. All of this spending sounds great in theory but it ultimately gets decided on by bureaucrats. Most of these bureaucrats can and will be influenced. With hundreds of billions of Dollars at their disposal, those that ultimately receive the contracts will usually be those that have the most influence. Once the Treasury gives the money to the states, it will be difficult to track. Even that money that will be doled out by the Feds is open to influence and corruption. Massive new government spending almost always leads to massive new government corruption and influence. Just because we are in a period of economic malaise doesn't mean that those with influence will not do to this what they have always done to such projects. It is almost surreal and absurd. Only three years ago there was a multi hundred billion Dollar highway bill passed. If we are still in massive need of new infrastructure, where did all that money go to?

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