Turning Japanese

The proprietor of this site routinely chastises President Obama for his hollow promise that the vaunted “Stimulus Package” would immediately result in job creation and hold the unemployment rate to 8%.  Unemployment is now 9.4%, and every week, when the new unemployment claims statistics are released, the President gets the piñata treatment, and deservedly so.

Further, despite the President’s claims last week that he has “brought the economy back from the brink of disaster,” there are serious short and long term concerns about prospects for growth and employment.  Q2 GDP was still negative; Q3 may show stabilization or even positive GDP growth, but it will in all likelihood be only temporary.

In fact, it is becoming increasingly clear that ObamaNomics is nothing but a misguided rerun of the very policies that have brought two decades of economic misery to the people of Japan.  Those of us who remember the eighties recall that Academia – in particular, the Paul Krugman of the day: Lester Thurow – was enthralled with “Japan, Inc,” urging America to reach economic nirvana the Japanese Way.  But a recession hit Japan in 1990, and her economy has still not recovered, after nearly two decades.  We will come back to this gloomy narrative later.  But be warned:  the upbeat tone you are starting to hear in the main stream media doesn’t exactly fit with reality.

To set the stage, we need to quickly review the economic policies available to the Fed and the Administration, which ones they have chosen, and how they are working.

Measuring the Business Cycle, and Policy Tools

Who decides if we are in recession or not?  The National Bureau of Economic Research (NEBR), that’s who.  Historically their definitions of recession correspond to the coinciding upturns and downturns of four key variables that measure economic performance:  1) unemployment, 2) manufacturing and trade sales, 3) industrial production, and 4) personal income.  Talk of “green shoots” in the mainstream media aside, none of these have turned upwards yet.  The numbers are clear: through Q2 we are still in recession.

Monetary Policy.

The Federal Reserve controls monetary policy and tries to jumpstart the economy by buying Treasury debt, or lowering interest rates.  These measures are often referred to as “printing money” because the practical effect is to create and circulate new dollars that did not exist before.

The goal is to make borrowing/lending – and in turn spending – easier.  The concern often associated with this tool is inflation, with borrowing and spending driving up prices.  We will come back to that.

Fiscal Policy.

The second tool available is fiscal policy, implemented by the President and Congress.  There are two stimulative approaches they can take: government deficit spending, or tax cuts, allowing the people get to do the spending.  Which is better?

Massive government spending – The Stimulus Package – has been the approach taken by Congress and the Obama Administration.  Critics observe that it’s an irresponsible quick fix, piling up debt to finance  spending today, leaving a higher tax burden on future generations.  Also, if that debt gets too high long term interest rates will rise dramatically, choking off the economy down the road.  Spending may be directed at worthless projects, or those that favor political allies rather than benefit John Q. Public, and will not result is sustainable long term growth.  Said another way, when the stimulus spending is over, you are in the same place as when you started, except you are in hock up to your eyeballs.

The alternative form of stimulative fiscal policy – tax reduction – is simply putting money back into people’s hands to spend.  It, too, leads to increasing debt, but proponents of this approach note that it works immediately, there is no need for “shovel ready” projects and no need to construct bureaucracies to  administer it.  Proponents of this approach also observe that there is no one better to decide what to do with their money than the American people.  Do we really need to send our money to Washington so President Obama or Nancy Pelosi and their staffs can decide?  Finally, wisely spent dollars lead to economic growth and higher tax revenues in the future to deal with those debt issues.

However, the current Congress and Administration obviously want absolutely nothing to do with this approach.  Setting aside the observation that Democratic politicians never seem to want to reduce taxes – keeping the booty so they can buy votes by handing out goodies and thereby retain their power – the argument against tax cuts is that people will simply hoard the money, or retire debt and so not spend.

Hey, Coach.  What’s The Game Plan?

Monetary Policy.

The Fed has injected sharp economic stimulus the past year, buying US Treasury debt at a torrid pace which it now holds as an asset on its balance sheet (just like you might hold CD’s).  In fact, the Fed has doubled its balance sheet, but so far we see no evidence of increased lending/borrowing, GDP growth, or the dreaded inflation.  Statistically, through the end of June the 3 month percentage change in bank credit plus commercial paper remains negative, as it has for about a year.  GDP is still contracting, and inflation is nowhere in sight.

What’s going on? The answer of course is that the monetary surge was overcome by another factor.

What other factor?  There is no point in going into quantitative hyper-technical detail about aggregate supply and demand curves, money velocity or money multipliers.  Let it suffice to say that the excess money has been soaked up into bank reserves, and not converted to new loans.  But it is new loans – and productive things to do with those loans – that consumers and small businesses need to get the economy going again and halt job losses.

So far, consumers are still retiring debt, unemployed, or worried about becoming unemployed.  As discussed below, the demand for loans by businesses for expansion is low.  This is due in no small part to uncertainty and fear inspired by a decidedly anti-business, anti-capitalist Administration.  Economists call this a “liquidity trap” and liken the policy to “pushing on a string.”  We have a long way to go before this monetary stimulus shows up in GDP growth.

Fiscal Policy.

Everyone knows that the Stimulus Bill was the cornerstone of the Administration and Congress’ attempts at a fix.  However, despite the President’s promises, as a cold hard empirical fact, it hasn’t yet worked.  Unemployment continues to rise, through Q2 GDP continues to contract.  Debt is piling up.  And so now they are starting to talk about Stimulus II.  What happened?

Well, a number of things.  Not all the money has been spent.  That’s like not taking your medicine and wondering why you are still sick.  Q3 will probably see the biggest effect.  However, what has been spent isn’t exactly productive.  You have all heard the stories.  Digging holes and filling them up again doesn’t go far, or last.  What are essentially payoffs to political pals, or spending on pet projects like “green” energy can be just like money poured down a rat hole.

Second, the Administration’s policies and posture have businesses – the entities that actually make GDP and employment grow – scared to death.  Suppose you were a business person and every time you saw our President or Speaker of the House give a speech all you heard was business bashing:  profit is evil, advocating more rules and regulations that make hiring more expensive; and higher taxation.  Would you invest or expand your business?  Would you hire?  Of course not.

I make my living dealing with small business owners, and they are hunkering down like turtles in a shell.  Who can blame them?  They are rich today.  They will be rich tomorrow.  They don’t have to take on additional risk and effort.  Why would they?

With all that debt piling up (the ratio of debt to GDP is expected to double during the Obama Administration, reaching 75%) business people should be worried about future economic activity – and higher taxes – down the road.

Lastly, state and local government’s are at odds with the Federal government.  Local government’s did what government does: they spent money like drunken sailors in the good times and didn’t save for the bad times.  Now, as the Fed’s are trying to stimulate, local government is broke, cutting back spending and raising taxes.  Take a look at the finances of California, Michigan, New York or my home state of Illinois.  (All Democrat controlled, and following liberal economic policies by the way.)  A total mess.

Uh, Coach?  It’s the Fourth Quarter and We’re Losing….What Next?

Perhaps only some of the older folks will remember the line from a pop song in the 80’s:

“Turning Japanese,

I Think I’m Turning Japanese,

I Really Think So”

But it’s looking more and more like we are headed for what Japan experienced:  a decade-plus period of quasi-recession and stagnant growth.  The Japanese tried the Obama/Pelosi way.  In fact they implemented Stimulus I, Stimulus II, Stimulus III – about ten in all.  They practically paved over the entire country with more public works projects than you can imagine.  It did no good.  Why?  Go back and read the section titled Fiscal Policy.  Spending must have some real and productive purpose, not just make work.

Once you’ve paved some new roads, built a few unnecessary buildings and squandered money on political gifts, then what?  Just like Japan did, President Obama and Speaker Pelosi are already talking about Stimulus II.  Any wonder?  In econo-speak:  the spending multiplier is low.  You aren’t getting the bang from spending they said they would.  There is academic evidence that this is the case.  Japan is now a debt riddled, government-spending dependent shell of its former self.  Move over Japan, here we come.

Congress and the Administration could suddenly correct its ways, cut taxes (the one policy they haven’t tried) and reign in an inefficient and largely unproductive public sector.  The one program that actually put cash (or value) into people’s pockets and got spent immediately was the Cash for Clunkers program.  Now, I have lots of criticism of a program that has taxpayers subsidizing a new car purchase for their neighbor, but do you see what direct value placed in the hands of John Q. Public does?  It works right now!

Did people “hoard” the money, like critics of tax cuts claim they will do?  This is all very odd, because President Obama’s own economic advisor, Christy Roemer, was a co-author of the primary academic work on tax-cut multipliers.  She says it’s 3.  That’s way more powerful than the spending multiplier.  But they won’t stop spending and cut taxes.

They could also stop cursing business and the profit motive and let people get back to the business of investing, expanding and hiring.  We could reduce another form of tax on US consumers – energy costs – by allowing oil and gas drilling.  But that’s not permissible because they have to pander to wild eyed greens with strange notions of exotic energy alternatives or returning to a lifestyle like the GEICO pitch man – even a cave man can do it.  So, with this Administration and this Congress there is no hope of expanding oil and gas drilling.  None.  Why let good policy get in the way of populist politics and a statist philosophy?

In the shorter run, a close look at all of the economic statistics that came out last week and provided  cover for the President’s  “return from disaster” comments suggest that hopes that the recession is ending are too optimistic.  Even in the face of huge government transfers, consumer spending growth is a negative 1.2%, and commercial construction is declining at a 9% pace as is equipment and software.

Residential housing spending is down.  The quarter benefited from three aberrations, a pop in defense spending and foreign trade, and the temporary stimulus spending effect, which will probably run its course in Q3.  The only good news is that inventories are quite low.  But that simply means we stop falling, it does not imply replenishment and growth.  Only consumer and business spending will bring growth.  And those turtles are in their shells.  If the President starts pushing hard for Stimulus II, you’ll know that he knows what I am saying is true.

None of this is good for the average guy.  If you happen to have an old car that meets the federal definition of a “clunker,” I guess you can get $4,500 of your neighbor’s money for a few more months.  But this is no way to run a successful economy – tax the mean rich (who will just shut down) and deficit spend for the benefit of a few chosen cronies.

For those of you who voted these guys in, or will vote for them again, I implore you to read about Japan.  It isn’t pretty.  If after that you still support ObamaNomics, we have a saying in my firm: ‘be very careful what you do or wish for, or you might just shoot yourself in the foot.’