Commentary: Why the Stimulus will not stimulate
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| Published on Tuesday, May 6, 2008 |
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By Gilbert Morris
The recent stimulus will likely add $50 to $70 billion dollars to the trade deficit and another $300 to 500 dollars to $19,000 in American household debt.
By now, you are familiar with our way of thinking: conventional approaches to economics usually rest on contrivances. Here are the “buzz words” to listen for: The stimulus will be “aimed” at the middle class; or, it will be “targeted” at everyone who pays income taxes; or rather those who pay payroll taxes will receive a “rebate”; all of it hardly more than contrivances aimed, targeted and likely resulting in little more than political showboating.
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| Dr Gilbert NMO Morris is an economist & legal scholar who taught at several American universities. He founded The Landfall Centre for Finance, Trade & International Affairs, which gained international prominence advising financial centres during the blacklisting. He is Chairman of CAICOS Brothers LP & MDB International. |
First, whenever one aims, or targets tax policy, one is engaged in income redistribution which is always inefficient and produces unintended consequences. Second, in varying sums, both Democrats and Republicans in America (with implications for us all), each refuses to see sense on this question. They suggest on a sliding scale that low income families will receive $1,500 -2,000 each. Or that Middle Class families may get as much as $5,000 each. They will then spend this money – so it is said – and this will stimulate the economy.
This is utterly foolhardy. But let us go at the question with a studied approach. First, what ails the US economy is not consumer spending but structure. So aiding consumer spending by bribing the American people does nothing about the ailing structure. There is nary a single economist who seems to understand how that economic space evolved more in the recent 15 years than the last 50, and more in the last 2-1/2 years than the last five.
Second, as to structure (or stature, if you like) if credit is calories, then the US economy is obese. It has gorged itself on credit by borrowing 80% of global savings. Its population constitutes 4.6% of the world’s population. But it consumes 47% of what the rest of the world produces (Which is why the Stimulus will grow the deficit). Additionally, the reason America can borrow so much of global savings is
(a). The world has faith in the American banking system (you can count on one hand the nations in which bank information is safe from political mischief)
(b). The US has largely standardized the material balance sheet (the things one must have) of what it means to be Middle Class; which in turn, drives further consumer spending through “consumption envy” (which is why household debt will increase).
So that this cycle does not undermine growth (now projected at 1.9% for 2008/9), American political leadership must understand how the economy works structurally; finding ways to return the family home into an ATM, essentially.
15-20 years ago the suburbanization of America was in full swing... with nearly 50% of the population, having left the urban centres, settling in suburbs. This provided each of those families with a basic asset they could leverage: the home. Second, banks were replaced by mortgage brokers as the primary source of retail mortgages, creating two impacts:
(1). An unprecedented competitive environment, (leading to predatory lending),
(2). An asset pool which meant interest rates could come down because of the value of the underlying collateral, which was the homes themselves.
In geo-political terms, there was a wide variety of crisis that drove cash into the American banking system: Asian Financial Crisis, Mexican Financial Crisis and the Argentine bond collapse. This increased the flows of ‘safe haven” savings into the US. In the gestation period, housing prices climbed, and so did consumption, since house purchases forecast broader consumer spending on furniture, appliances, gardens and lawns etc, etc. In particular, credit card companies facilitated this by providing credit, either as part of a refinancing package or draw-downs on equity built up through mortgage payments and appreciation.
The entire thing was a self-perpetuating bubble, which was sustainable, so long as homeowners paid their bills and inflation remained shoved into some other asset, such as equities; where ostensibly wealthier people could waste money on overpriced stocks. (You should note here a profound disagreement with Mr Greenspan in particular that I wrote about two years ago).
However, there are no forces pushing global savings into the US now. Instead a combination of rigid rules (after the PATRIOT ACT) and the growth of emerging markets (China, India, Russia, Brazil) means the global savings which were the foundation of the credit juggernaut is not as available. That means the return of housing, which means the return Middle Class Americans to economic health is a long way off.
In considering the way the structure fell apart, think of how the home become a “bank machine." Mortgages came to be bundled as asset backed debt financial products, or CDOs, which could be traded. And brokers – feeling the pull of the equity and debt markets – had every incentive to add more and more mortgages to the pool; including bad ones.
As I explained in recent articles, mortgage brokers bundled the mortgages, banks loaned the money by taking percentages of the debt in different classes, prime and subprime. Aggregators bundled the mortgages into securities, Banks in turn – almost as if eating their own flesh – invested in these instruments, along with funds (Hedge and Private Equity Funds), purchasing bonds for their investors; usually pension funds, insurance companies and (believe it or not) banks, yet again; this time as investors or counterparties (depending on structures) rather than as lenders.
Now here is the problem: you will have seen that banks all over the world have written down nearly $400 billion dollars in losses. However, there are things which have not had an impact as yet: this Spring, more than $2 trillion dollars in adjustable rate mortgages will be... well, adjusted, and a new wave of homeowners will not be able to pay. Added to that, the bondholders (Funds, Pension Funds, Insurance Companies, etc) may begin to sell the bonds below the purchase price (which has obviously fallen below their yield projection already). This will bring additional mind-numbing losses. But we are not finished, homeowners will learn the term “negative equity”, as some houses, though well built, will simply be found not to be valued at the purchase price. Others will find that the houses were not well constructed (lemon houses), and so can never meet the purchase prices.
The stimulus will do nothing to correct any of these problems. It may even entreat those receiving it to leverage it for more credit.
What has to happen? Pray! | | | | Reads : 217 | | | |
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