blind_html [Fwd: The Market Is Shorting Obama's 'Stimulus']

  • From: Nimer <nimerjaber1@xxxxxxxxx>
  • To: blind_html@xxxxxxxxxxxxx
  • Date: Fri, 20 Feb 2009 17:57:12 -0700

-------- Original Message --------
Subject:        The Market Is Shorting Obama's 'Stimulus'
Date:   Sat, 21 Feb 2009 00:03:41 -0000
From:   Ray T. Mahorney <coffee-craver@xxxxxxxxxxxxxx>
Reply-To:       Blind-chit-chat@xxxxxxxxxxxxxxx
To:     <Undisclosed-Recipient:;>

(for those who need reminding, whither the market goes main street follows.)
February 20, 2009
The Market Is Shorting Obama's 'Stimulus'
By George Bittlingmayer & Thomas W. Hazlett

President Barack Obama’s “stimulus” plan invokes the 1930s fiscal strategy put forward by British
economist John Maynard Keynes, who saw capitalism as pretty
much spent. Having exhausted their store of innovative ideas, investors curled up. Workers lost
jobs, spent less, and sent still other workers walking.
Budget deficits ��" government spending without taxes to “pay as you go” - would pull unemployed
workers off the street and arrest the downward spiral.
Investors’ “animal spirits” would be calmed, new capital risked, and economic vitality restored.

So the Obama theory ��" government spending is stimulus. If so, financial markets should feel the
love. The U.S. budget is awash in red ink, and $800 billion
more of it should easily move the needle on our economic prospects. Indeed it has ��" in the wrong
direction. Financial markets don’t want more government
debt or a scramble for “shovel-ready” spending projects. They want the skeletons in the banking
sector’s closet exposed and expunged.

The Bush Economy went up in smoke in September-October 2008. The financial meltdown hit Wall Street,
devastating bank equities and laying waste to America’s
401-Ks. The Republican ticket, McCain-Palin, was a 50-50 bet on Sept. 15; by Oct. 15 it was a 5-1
long-shot. Voters saw the carnage: the Dow Jones Index
lost 17% of its value from Sept. 2 through Nov. 3. In a flash, Americans lost years of toil, and
Republicans the election. Decisively.

The election marked a turning point. Investors looked forward to the economic policies crafted by
Democrats in Congress and the White House. More pointedly,
they wanted decisive, well-crafted action on the banking crisis. Hence the Dow soared 6.5% Nov. 21
on news that Timothy Geithner, the highly-respected
head of the New York Federal Reserve Bank, was Obama’s pick for Treasury Secretary.

Yet, from Nov. 4, 2008 through Feb. 12, 2009, the DJI overall fell 18% -- a larger drop than during
the Sept-Oct plunge. In January, when the Obama plan,
promising far greater deficits than the two much smaller “emergency stimulus” plans signed by Pres.
George W. Bush in 2008, was unveiled, the market tanked
��" the worst January performance in 113 years.

More pointedly, key political victories for the Team Obama spending plan have not been viewed as
buying opportunities on Wall Street. A string of negative
market reactions began with the December 18 announcement of a stimulus bill of $700 billion (Dow
down 2.5%), continued with the January 7 announcement
that the actual plan would be “on the high side” (-2.7%) and continued with last week’s 61-36 Senate
vote supporting the Administration’s fiscal plan.
The White House victory and the new bank bail-out plan announced the following day by Treasury
Secretary Geithner were met with a 5% wipe-out in the DJI,
and a decline in Treasury bond yields, indicating a “flight to quality.”

There are many problems with Keynes’ “stagnationist thesis,” as Joseph Schumpeter called it, not the
least of which is that it didn’t test so well when
applied by New Dealers. U.S. unemployment was perniciously high throughout the 1930s, peaking at 25%
in 1933 but still over 17% in 1939.

Many claim that World War II brought us out of the Great Depression, but the lesson to be learned is
still being debated. Federal budget deficits soared
(reaching 26.5 % of GDP in 1942 as calculated by Harvard economist Robert Barro), providing
Keynesians an argument for spending as stimulus. But WWII also
brought a profound shift in the New Deal’s regulatory policies. Attorney General Thurman Arnold’s
vigorous campaign to break-up “the bottlenecks of business”
in major industries like steel, chemicals and electrical equipment was shuttered, and America’s
largest corporations enjoyed a respite from threats of
dismemberment (Arnold was kicked upstairs to a judgeship). As Thomas K. McCraw writes in his
superlative Schumpeter biography, “Under the life-and-death
pressure of war mobilization… the Roosevelt Administration, which had been hostile toward alleged
monopolies, now decided that big business must lead in
the job that had to be done.”

The only thing guaranteed by the spending stimulus is more national debt. One stroke of the
presidential pen has now increased it by $800 billion. Democrats
recently screamed about W-era profligacy. On July 28, 2008, Sen. Kent Conrad (D-ND), Chair of the
Senate Budget Committee declared, "If they gave out Olympic
medals for fiscal irresponsibility, President Bush would take the gold, silver and bronze. With his
eight years in office, he will have had the five highest
deficits ever recorded. And the highest of those deficits is now projected to come in 2009, as he
leaves office."

Kent Conrad was right. The projected 2009 deficit then stood at $482 billion. In January it was
forecast by the Congressional Budget Office at $1.2 trillion.
Pres. Obama’s new plan now ups that to $1.7 trillion. If W got the gold, the new Administration has
landed the Platinum in just its qualifying heat.

If historic U.S. budget deficits are any indication, the economy is already “stimulated.” The
predicted 2009 federal deficit stood at 8.3% of GDP before
Obama’s package sent it to about 12%. This is a stunning level of debt, double the previous post
WWII high when Reagan’s 1983 budget deficit amounted to
6% of GDP. That time around, the 10.8% unemployment rate, the worst since the Great Depression, was
soon reversed.

Keynesians claim that the Reagan boom was an outcome of just this deficit strategy; for sake of
argument, let us assume the Keynesian position. Reagan’s
budget deficit, half the size of Obama’s as a fraction of GDP, was able to pull the economy out of
an unemployment trough deeper than the 7.6% hole we’re
in today.

How do economists know that, while a deficit amounting to 6% of GDP budget was sufficient to spur
the economy back to health in 1983, it will take more
than twice that federal borrowing to do the same now? They don’t. Economic models are all over the
place in their projections. Indeed, Prof. Barro’s cutting
edge analysis of fiscal policy finds no historical stimulus from peacetime deficits. Of course, we’ve
never seen so massive a deficit ��" one that would
bar the U.S. from membership in the European Union, on grounds that our government finances are a
mess -- and so we lack empirical evidence to inform the
precise experiment we’re running today.

We do, however, know the accounting trends: our government faces massive new spending increases as
Baby Boomers retire and their Social Security and Medicare
bills come due. Market investors are wary of new spending, guaranteeing either future tax increases
or inflation, as a run-up to the demographically guaranteed
spending spiral. The quest for “shovel-ready” projects makes one think, Where’s Senator Ted Stevens
when we need him? In any event, this fiscal bridge
to nowhere is not spurring markets.

Government deficits are nonetheless being sold as doctor’s orders, an elixir that ��" while it looks
ugly and tastes bitter ��" will propel us back to economic
health. Yet the best forecast currently on the table is the one made by investors risking their own
money. They are shorting the “stimulus.”

George Bittlingmayer is the Wagnon Professor of Finance at the University of Kansas. Thomas Hazlett
is Professor of Law & Economics at George Mason University.

Page Printed from: <> at February 20,
2009 - 05:58:43 PM CST
Ray T. Mahorney

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