Slowing the Downward Slide

I’d like to focus on some potential policies that could see us through this difficult economy.  It should be apparent that we’re in for a period of time where uncertainty will cause a lot of stress in the financial markets.  The uncertainty has bled into the ‘real’ economy where we’re seeing increasingly higher levels of unemployment and distress in industries outside the banking world.  If you haven’t noticed, the Fed has been actively working on this for some time.  It’s major tools indirectly impact the real economy by influencing the credit markets and the availability of loans.  It’s pretty straight forward actually, in a normal economy, low interest rates would cause banks to lend to more businesses and households and this would stimulate the economy out of a recession.  The problem right now is that losses from loans are creating such problems for bank profitability, banks are holding the money.  We have extremely low interest rates right now.  This is a situation that we saw in Japan during the 1990s.  It took a decade for the Japanese economy to snap out of it.  The Fed’s rate to banks is 1% right now.  It is cheap for them, and now many other financial institutions to borrow from the Fed.  There is still some constipation, if you will, in the banking system.  What is worse, some of the money sent to these banks that has gone to healthy banks is going into buying other banks.  None of this will help stimulate the economy.  So how do we avoid Japan’s stagnant decade?

If you know me, you know I do not favor bailing out the automobile industry.  We have a system to help corporations rearrange their obligations and make themselves more able to carry on in the future.  It is called bankruptcy.  We’ve watched the airline industry go into the bankruptcy process and come out as healthier companies.  Usually, all contracts between debtors and the companies are either renegotiated or foregiven.  The stockholders lose their stake.  The Unions will have to scale back on their contracts.  This will all happen in a very structured manner and all will have to sacrifice for the companies to survive.  I’m afraid that if we do not force them into this circumstance that we will find that we lend them money, only to have them pay creditors at the same losing level with the same bad managers.  The folks we could spend the money on would be the folks that do lose their jobs.  We can provide them with extended unemployment insurance and with job retraining.  We’ve seen the Treasury’s deal with bank result in outcomes we did not want:  no credit going to main street, bonuses and dividends still in tact, and buy-outs.  We do not need to repeat this mistake.

Do we need another stimulus package or do we need tax cuts?  If so, who should be the focus? Short term tax stimulus is probably in order.  However, if we spend all of this money, we will grow the deficit.  Growing the deficit is not a bad thing during recessions, however, we already are running a huge deficit and it’s getting bigger because of two wars and the Bush tax cuts. If we continually push 10 year bonds out to the market, there will be a point where the big money (mostly soveign wealth funds) will begin to balk.  Rates could go up which means that we could spend a huge amount of money just servicing the debt.  Any stimulus should be short-lived and should focus on the middle and working class.  Tax increases, even on the wealthy and on corporations, should be avoided for several years.  The adminstration will have to scale back on its offerings of new benefits and programs.  I don’t think we’ll see work on the health care system right now because other things will take priority.

There are two areas where new spending should be encouraged.   These are energy independence and infrastructure rebuilding.  This does not mean building new bridges to nowhere, but fixing our aging infrastructure.  This expenditures will create future economic growth and can provide jobs during the recession.  Grants to states for specific purposes can be used so that states with the biggest problems can get the highest priority.  There are challenges to this, however. The biggest problem with major programs like this is getting them to move out of congress and committees.  This can take so much time that the projects may never have an impact. Since the Democrats have strong majorities in both houses, they should be able to usher through these types of programs.  These need to be expedited.  The one big thing I worry about here is that they will not focus on what is best, but will focus on enriching groups that supported election winners. Projects providing jobs that focus on building our future potential would be a lot better use of funds than just giving folks extended unemployment benefits.   Hillary Clinton’s green jobs program and McCain’s cap and trade system to reduce green house gases are both good programs.  Jobs could include retrofitting existing houses to be more energy efficient.  The focus needs to be on the underlying capital that leads to future growth so that even if some of them are slow to develop, there will be economic development.

The focus during the rest of this year and into the next will undoubtedly be dealing with the ongoing slow-down in the economy.  We will soon see if we will get real change or just a bigger deficit with spending that accomplishes little.  I’m worried about the quality of the spending, because as I said, most of our debt is financed by the international community.  There are many other places to park their wealth.  If they pull it, U.S. citizens will not be able to come up with the difference without getting use to much higher taxes.