Chasing the unknown

Feb. 1, 2009
The proposed stimulus leaves more than a bit of doubt as to how successful it will be. Not only has the stimulus approach changed several times in less than two months, the size has moved with the political atmosphere rather than the economic requirements. A stimulus of this magnitude does not have a second chance to work. It seems like the proponents (I am one of them) can't see the linkage between

The proposed stimulus leaves more than a bit of doubt as to how successful it will be. Not only has the stimulus approach changed several times in less than two months, the size has moved with the political atmosphere rather than the economic requirements.

A stimulus of this magnitude does not have a second chance to work. It seems like the proponents (I am one of them) can't see the linkage between the stimulus and the results expected. There has been no discussion of what the benefits would be for each segment of the proposed stimulus package. It seems unlikely that we will ever know what the expectations were for several reasons.

First of all, they are wrong. No one can correctly forecast the effect on the housing market of a stimulus that will buy up foreclosed mortgages with any degree of accuracy. We can only forecast the future using historic evidence — and there is none to model in this situation.

There is evidence of the impact of major public works programs, so one might think we should be able to estimate the employment benefit and the sustained benefit of the public works efforts. From the list of projects being proposed by those seeking funds (such as building hotels and museums), one has to wonder about the overall public good being served. There will be oversight as to the allocation of the $800 billion plus stimulus by those who have conducted oversight in the past. The Senate and House have clearly signaled that they are not bound to the procedures proposed by the incoming administration, so the pork will fly.

One of the most effective stimulus proposals is a tax cut, which is meant to put more disposable funds into the hands of the consumer. Last year, we found that a good deal of the funds directly distributed to taxpayers went to pay off debt. That does not lead to an increase in consumption in the short term, which is the time period sought by the stimulus. It is unknown if the same would happen again, but we do know that late payments on revolving debt are on the rise, so it is likely that debt will be paid off again this time around.

There is the issue of the debt to be generated, but it truly pales in light of the deficit to be encountered with Social Security and Medicare imbalances. Estimates have put the total in a few years in excess of $50 trillion for all Federal debt, which means the U.S. could produce goods and services for almost five years and all the proceeds would have to go to pay that imbalance. The argument is that adding another $2 trillion won't hurt that much more.

If the stimulus works, the economy will grow faster than it otherwise would and we can generate more funds to pay off that debt sooner rather than later; however, that requires an increase in taxes and/or a decrease in entitlements. In either case, we have a requirement of higher taxes and reduced entitlements in the future.

The requirement occurs when one provides a reasonable payment of interest on the debt, say 4%. If we are to be fully funded, the interest cost each year is $2 trillion, about 1.5% of GDP. Interest payments are not counted in GDP and the funds will have to come from elements within GDP. Thus, potential GDP is reduced by 1.5% just to pay the debt.

As the primary holders of the debt are not U.S. citizens, foreclosure could take on a whole new meaning.

About the Author

MARTIN LABBE e-mail: [email protected].

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