The views expressed in this column are those of the author and not SVB Financial Group.
With the economy tipping over into a second downturn and the big guns of fiscal and monetary policy already spent, it may be time to look at some of the fundamental psychological barriers to economic growth. Just to recap, the Fed has provided about $1.5 trillion in liquidity using their own balance sheet. They have increased free reserves in the banking system one-hundredfold to over $1 trillion, effectively loading the banks with excess liquidity for lending. Meanwhile from inside the Beltway, our elected officials have delivered more than $1 trillion in direct stimulus from the Bush ($168B) and Obama ($862B) measures and an additional $3 trillion of deficit spending in the last two years alone.
Yet none of this has inspired businesses to invest or households to spend. Well, there are a couple exceptions. Cash for Clunkers drove a dramatic increase in new car sales and took 690,000 used cars off the market, driving used car prices up 30 percent at least temporarily. The $8,000 housing subsidy for first-time buyers created a surge in demand for houses. Unfortunately, neither program has produced a sustained impact. The effect was similar to buying your three-year-old a churro at the ballpark in the second inning, enjoying an hour of excited focus on the game only to watch him snooze through those critical late innings with the game tied 5 to 5. The stimulus-driven sugar high produced 5 percent GDP growth in Q4 2009, but quickly faded to a 1.6 percent slumber for Q2.
So with deficits sky-high, the Chinese questioning our economic management and worried about their credit exposure and the populace in a surly mood about dramatically higher taxes, can the Obama administration afford to buy us unlimited churros as Paul Krugman suggests? Further, does the Fed have any weapons left to fight off a second contraction?
On the first question, we think the answer is no. Fiscal policy is tapped out unless it shifts to a reduction in marginal tax rates for households or businesses. Simply tossing more money into ideas that have failed will not fly with the voters. The vast majority of the country has seen no meaningful benefit from the $4 trillion in stimulus. This is why polls now suggest that a majority feels that more government spending is bad for the economy.
On the second point of the Fed's arsenal we turn directly to Chairman Ben Bernanke. This seemed to be the key question he wanted to address in his remarks at the annual Jackson Hole confab of central bankers. The Chairman reviewed the various options that had been deployed so far and attempted to make the case that there were more arrows in the quiver. It all reminded us a bit of that scene in Monty Python and the Holy Grail when the armless Black Knight declares, "It is only a flesh wound!", as he struggles to fight on by kicking King Arthur in the arse.
To be fair there are other weapons the Fed could deploy, albeit with some shift away from their normal operating theater. For example, instead of buying up more mortgage paper they could simply buy every unsold home in the country and bulldoze them. The current supply is about 12 months or 4 million homes. At a median price of $185,000, the lot could be had for a mere $740 billion. This would create an immediate housing shortage, increasing prices and household net worth in the same way that Cash for Clunkers drove higher prices for used cars. It would also create jobs for bulldozer drivers.
You are probably laughing at the absurdity of this idea, but on a much smaller scale it is no different from the ultimate Keynesian solution to the Great Depression. In that instance, deficit spending was used to hire millions of men who were sent abroad to destroy the productive capacity of the planet. When it was over, there were lots of high paying jobs rebuilding and replacing what had been lost.
Finally we turn to an important observation of Lord John Maynard that economists have often overlooked. It has certainly received short shrift in the policy debates today.
"Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits - a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities."*
We think these natural animal spirits have been buried by the "unusual uncertainly" engendered by the political foment in the land. Households and businesses have a preference for inaction in the face of extreme questions about taxes, health care, energy use and regulation. It is better to carefully husband resources for survival than to take on new risks or new ventures. As evidence, witness the $2 trillion in cash reserves on corporate balance sheets and the consumer savings rate at a high 6 percent.
What can policy makers do to reinvigorate those animal spirits? Probably nothing since trust in the government is so low any policy action today will be met with skepticism. Maybe we just need the politicians to be quiet for awhile. After suffering two years of constant attacks from Washington, the private sector might prefer to heal its wounds in silence. This cannot happen soon as the chaotic political debate will rise to a crescendo leading up to the November elections. After that, well, anything is possible.
*John M. Keynes, The General Theory of Employment, Interest and Money, London: Macmillan, 1936, pp. 161-162.
The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or Silicon Valley Bank, or any of its affiliates. This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is it to be relied on in making an investment or other decisions. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction.