Search The Web

Today's Headlines

Tuesday, June 19, 2012

Why The US Should Spend Its Way Out Of This Recession . . . And Why It Won't

So, the US Congress and the President are locked in a battle over the budget priorities that should take precedence right now.  President Obama and the Democrats want to stimulate the economy with more government spending to create more growth and jobs so that the economy can grow vigorously and unemployment can be brought down.  The Republicans want to hold the line on spending, and rein it in even further so that debt levels go down or at least stay where they are, regardless of such austerity's effects on the economy.  Their argument is that if the government gets its debt house in order, that will encourage private investment, resulting in economic growth and job creation.

But, is it really such a stark choice?  What if there is a way to spend money to goose the economy without worrying about the debt spiraling out of control?  Maybe, there is actually such a way, and it is getting lost in the ideological battle going on at the highest levels of the government.

Last I checked, the US government-issued 10-year treasury notes (T-Notes) is 1.62%.  Also, last I checked, the inflation rate of the US in the last 12 months was 1.7%.  It was actually an annualized 2.3% in April, but because of a sudden steep fall in fuel prices, the May inflation numbers came in much lower than expected.  The average US inflation rate over the past 100 years has been about 3.4% per year.

What does all this mean?  It means that the real interest rate of a 10-year T-Note right now (actual interest rate - inflation rate) is actually negative.  So, investors are paying the US government money for the privilege of lending the US government money!  For every dollar the US government lends out at this rate, the government actually makes money!!

What would you personally do if people from around the world lined up and offered to pay you money to borrow from them?  Would you not be raking in the money hand over fist as fast as you possibly could?  Unfortunately, it does not happen to you or me.  Ever.  In fact, it almost never happens for governments either.  But the US is in an extremely sweet spot right now.  It is large and stable.  There are no systemic risks like there are with its only global competitor, the Euro-Zone (which, by the way, could probably take advantage of such interest rates if they decided to issue Euro-Bonds instead of individual country-backed bonds they have stuck with so far).

Obviously, once the US does start taking advantage of these negative real interest rates, the interest rates will start moving up slowly.  That is just the way the law of supply and demand works.  Right now, there seems to be a severe shortage of US 10-year T-Notes in the world, so people are willing to pay a very high price for every one issued, making the absolute interest rate miniscule, and the real interest rate negative.  Once the supply of US 10-year T-Notes goes up, its price will fall making the absolute interest rate higher.  Eventually, the real interest rate will become zero and then positive.

But, right now, the window of opportunity is still open.  This is what I would do if I were in the enviable position the US government seems to be in right now:  I would issue as much debt as I could at negative interest rates.  I would stop issuing debt only when the real interest rate on the debt becomes positive.  How much debt could the US issue at a negative real interest rate?  Who knows?  But it will probably be in the tens or hundreds of billions of dollars.

That money can then be used to stimulate the economy and create jobs.  Rebuild infrastructure.  Spend money on education, job-training, and research and development.  The effects on the economy and the unemployment rate can be quite immediate and dramatic.  Just the knowledge that the government is prepared to spend money on the economy is enough to spur private businesses that are sitting on the fence into growing and hiring.  Businesses that do not grow when the economy grows will be left behind, and businesses know that.

Obviously, fiscal hawks find all this talk of government spending quite distasteful.  But there are two reasons it should not be distasteful.  Firstly, as mentioned previously, the government is going to be making money on every dollar it lends out.  In fact, as the economy picks up steam inflation is likely to go up too, so the government can afford to borrow money at higher absolute rates and still make money in the process!

Secondly, this course of action should be embarked upon with the full knowledge that it is not going to go on for ever and ever.  In fact, there should be strict limits on when the government can engage in this.  First, the real interest rate has to be less than or equal to zero.  Secondly, the spending should be wound down as the growth rate of GDP exceeds a certain number and the unemployment rate falls below a certain number.

When the second condition is achieved, the economy is already on solid footing and the government does not have to support it with spending anyway.  At the same time as the government spending on these stimulus programs is winding down, government receipts increase because of increased tax revenues.  These extra revenues should then be used to pay down the debt that was accumulated during the economic weakness.

Ideally, the process should have worked in reverse:  the government should have accumulated a reserve of money in the form of fiscal surpluses during economic good times.  These reserves can then be used to stimulate the economy when such stimulus is needed, with borrowing being a last resort only if the reserves are found to be inadequate.  And the reserves should be rebuilt once the economy recovers.

After all, this is what most people with common sense do.  It is not rocket science.  When you are in a good job and can afford to save money, you are supposed to lay away some money for a rainy day.  When you hit a bump in the road in the form of unexpected expenses or a job loss, you are supposed to access your savings to get over the rough spot.

Unfortunately, just like the US government, people have been ignoring this for the longest time.  They have lived on borrowed money (credit cards, home equity loans and the like) instead of saving money for a rainy day.  They have hit their individual debt ceilings, and then broken through them with new credit cards and more borrowing.  Now, they have no cushion to fall back on when they face a real need, such as a job loss or unexpected medical expense.  Bankruptcy and foreclosure result.  Unfortunately, the average Joe cannot borrow money at a negative real interest rate to tide over tough economic times.

But, the government still has the wherewithal to weather this without further pain.  It can take advantage of record-low interest rates to finance a robust recovery spurred by government spending.  The question is not whether the economy can be stimulated in the short term at practically no cost right now.  The question is whether they will get fiscal religion, and start doing what needs to be done to clean their fiscal house for the long term.  Will they start paying down the debt and putting down reserves in advance of the next economic downturn?

The Democrats have tended to break the bank in the past by not curtailing government spending when the need for it no longer exists.  Short-term problems tend to get saddled with long-term solutions that are wasteful and create government spending long after the need for such spending is gone.  Will they have enough discipline to adhere to strict conditions on when the borrowing and spending needs to stop and the paying down of debt needs to begin?

The Republicans have tended to break the bank in the past by doling out tax breaks (and getting into unnecessary and expensive wars).  There is nothing wrong with tax breaks as long as the government's needs are taken care of before the tax breaks happen.  Has the debt been paid off and a sufficient reserve built up?  At that point there is nothing wrong with tax breaks.  But short-changing the government to give tax breaks to the wealthy is not a sound idea.  Government reserves are not a waste of money.  They are necessary to tide over the troughs in the economic cycle that are inevitable.  Hamstringing the government from being able to provide such stimulus will only make these troughs longer and deeper.  Will they have enough discipline to adhere to strict conditions on the size of the reserves required before tax cuts can begin?

Assuming the two sides are mature enough to make the commitments above in the spirit of true cooperation, the way out of this long recession is clear, and could be quite an easy path.  Unfortunately, the maturity of both sides is questionable.  Even if they could make the commitments required, their ability to live up to those commitments is suspect.  So, perhaps the US is doomed to muddle its way out of this recession much more slowly than necessary.  What a shame.

But I have always believed that in a democracy, the people always get exactly the government they deserve.  Different people can blame different parts of the government for their plight, but ultimately, it is a government of them, by them and for them.  If they cannot agree on who to blame, is it any wonder their representatives cannot agree on how to get the economy moving again?

Visitors Country Map

Free counters!

Content From TheFreeDictionary.com

In the News

Article of the Day

This Day in History

Today's Birthday

Quote of the Day

Word of the Day

Match Up
Match each word in the left column with its synonym on the right. When finished, click Answer to see the results. Good luck!

 

Hangman

Spelling Bee
difficulty level:
score: -
please wait...
 
spell the word:

Search The Web