Up in the air

The expectation for this year is that the economy will decline well into the second quarter and then begin to recover in the third. However, it could be better than that or worse than that. The reason is we do not know how the consumer will react to the stimulus packages that may be offered. It appears that by the end of the first quarter, nearly $150 billion will be passed along directly to consumers

The expectation for this year is that the economy will decline well into the second quarter and then begin to recover in the third. However, it could be better than that or worse than that. The reason is we do not know how the consumer will react to the stimulus packages that may be offered.

It appears that by the end of the first quarter, nearly $150 billion will be passed along directly to consumers to do whatever they see fit to do. How that will affect the growth of the U.S. economy is unclear. It is not likely to be enough so a second round of a comparable amount will be needed in the second half of this year. The total amount of the stimulus packages is expected to total nearly $700 billion over a three-year period with $300 billion out the door to consumers this year. The entire program will include direct payment to individuals, part will be to finance specific federal programs, and part will be to invest in infrastructure.

Preliminary indications suggest that the expected timing of the funding is $350 billion this year, $200 billion in 2010 and $100 billion in 2011. The first installment will be heavily weighted towards developing consumer demand, while the remaining will be more for investment stimulus such as infrastructure and alternative fuel development.

The uncertainty of the specific outcome is troublesome, but the sheer size of the effort may lift all ships. There are some basic results that seem likely. Let's assume that the consumer stimulus will lead to a near-term (two-quarter) increase in consumption amounting to about 40% of the funds distributed. Another 40% will go to pay off existing debt, both late mortgage payments as well as revolving credit. That would mean that a full percentage point was added to the GDP by this effort that would not otherwise have been in place by having 40% ($120 billion) spent by consumers.

The secondary effect of the remaining 60% ($180 billion) will be to provide some flexibility for the consumers to incur debt in the future (those paying off some debt), but that is restricted by the employment opportunities that will be slim to none for the first six months. The $60 billion that went into savings could optimistically spur some modest support to the securities market.

In sum, it looks good on paper until we have to pay the interest, which will amount to about $20 billion per year if financed with 10-year Treasury notes. Assuming one would want to draw down the debt over a 10-year period, the total cost to the government (taxpayers) would be $90 billion per year.

Currently, there are several thousand infrastructure projects ready to be put into place if funding can be provided. The hurdle here is that many states do not have the funds available to see the projects through to completion. New state construction bonds are unlikely in times of cuts in services due to tax revenue shortfalls. This one is tricky but can be addressed by relaxing co-pay terms for two years. The result would be a much-needed improvement/repair of the infrastructure along with improvement in the employment levels.

Some have estimated that over $600 billion is needed just to meet the current rehab effort of the Interstate system and aging bridges on secondary roads. That is far more than the amount being set aside at this time; however, the infrastructure repair is critical if we are to have a viable system for the transportation of goods and people.

Finally, there will be $100 billion or so to be used to fund development of alternative fuels and to make the current energy delivery system more efficient. Other than directly supporting jobs for this effort, the benefits will be much further down the road, although welcome if they prove fruitful.

The bottom line is that we are spending now with the uncertainty of payback compared to continued economic decline for all of this year. Tough choice.

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