Saturday, January 17, 2009

A Few Real Inconvient Truths

As the Obamanation gears up for a week adulation and worship, Mr. Quarter thinks it is prudent to look at a few facts and make some observations on the savior's proposed economic stimulus package to see if it makes sense. Perhaps in the process Mr. Quarter can educate the unwashed masses that give "The One" his 80% approval rating before he has even been sworn into office and actually assumed the responsibilities of the Presidency.

Let's start with a couple of well known public facts as assumptions in our analysis:
  1. The Democratic congress, at Obama's behest, is currently proposing an economic stimulus package of $825 billion in tax cuts and spending. This may swell to $1 trillion before it is sent to Obama's desk.

  2. Obama asserts in his speeches that he will create or preserve 3.5 million jobs with his economic stimulus package.

  3. Federal deficit spending projected for 2010, the first year of Obamatopia, is $1.3 trillion.
That means that the government will spend almost $236,000 to create each job. Rather inefficient by any measure. If the median income is around $40,000/year then it appears the program is that the government will subsidize those 3.5 million jobs at a 100% level for 6 years. Alternatively, is would appear that for the money spent, we should realize 6 times the new or saved jobs (21 million). By any measure it is a most inefficient program in terms of bang for your buck.

If you assume job creation every single day of a 4 year Obama presidency (i.e., 1460 days), jobs will have to be created at an average rate of almost 2,400 jobs/day or 72,000 job/month. To put this number into perspective, according to the US House of Representatives Committee on the Budget report issued on July 31, 2008 (a blatantly Democrat spin job, I admit), average job creation needed simply to keep pace with the growth of working age population is 150,000 jobs/month. During the years of the Bush administration, job growth averaged 58,000 jobs/month. During the years of the Clinton administration, job growth average 210,000 per month. Seems like we should get a lot more jobs for the money spent.

The theory of Keynesian economics is that the state should stimulate economic growth and improve stability in the private sector through spending and economic policy, for example: interest rates, taxation, and public projects. As applied in the current economic stimulus plan, the federal expenditures, tax credits and tax rate reductions will total $825 billion. The theory holds that government injection of money into the economy via these means will create excess consumer demand (more people have more money to spend) through jobs creation, etc. The demand is satisfied by spending the money on goods and services, which in turn creates the demand for workers to fill jobs to turn out goods and services, who then spend or invest their money creating more demand for goods and services. The initial feedstock of money is obtained by the federal government selling debt in the form of treasury bills/bonds to finance the spending and by the Federal Reserve buying bonds from banks and depositing the proceeds in the bank's reserve accounts creating excess reserves that the banks can loan.

Can we afford the Keynesian approach to stimulating the economy. While the Bush administration has been reviled as a profligate spendthrift, as a percentage of GDP, the annual federal deficit has been less than 3% annually on average, and less than the 5% average of the Clinton administration. Obama is now proposing annual budget deficits for the next several years approaching 10% of GDP. As you can see from the chart at the left, deficits of this magnitude have not been seen since WWII.

A critical assumption of the Keynesian theory is that the economy has the inherent means to satisfy consumer demand. Another way of stating this assumption is that the economy has sufficient manufacturing capacity to satisfy consumer demand and needs only to add jobs to increase output. Unfortunately, several factors mitigate against the success of Keynesian economics in the United states today. First, the process of globalization over the past several decades has shifted the basis of our economic growth to consumption rather than production. Businesses have moved factories overseas (China, Japan, Latin America) eliminating the capacity to add jobs in this economy. Second, this consumption has been fueled by consumer debt sending US dollars overseas. Third, savings rates in the US are near zero. Fourth, the largest holder of US debt and US currency reserves (our largest trading partner, China), has strong incentives not to invest its excess dollars here and to instead spend domestically to stimulate demand at home because the slowing of our consumer spending has caused a decline in its economic growth that could lead to regime instability.

Another factor that cannot be quantified is the willingness of foreign investors to continue to finance US debt by purchasing US Treasury bills and bonds. Presumably there is some risk aversion limit where US debt becomes so large and the expectation that that debt will be paid back becomes so small that absent huge interest rate increases, there will be no buyers. This will become especially critical as the baby boomer generation begins to draw social security and medicare.

Assuming that the stimulus package works initially as Keynesian theory predicts and more people have more money to spend, thus creating excess demand. First, how is that spending financed. By selling Treasury bills and bonds to foreign investors (a.k.a. China, Saudi Arabia, etc.). How is that excess consumer demand satisfied? By spending. On goods produced overseas. In China. So we send the stimulus dollars that we borrowed from China and Middle Eastern oil producing nations back to to China and Middle Eastern oil producing nations. How many new permanent jobs are created - not many. A few new low paying jobs selling consumer goods and pumping gas until the excess demand is satisfied. A few temporary construction jobs for infrastructure until the government spending stops. Then status quo ante.
Unfortunately, Mr. Quarter does not have much faith in the stimulus package at this point. The likely apparent outcome is that we will go deeply into debt as a nation and will not see any real improvement. Once again, politicians will stir up a great deal of dust and create the illusion of forward movement with no real progress realized. As a check on this analysis,one need merely review the improvement in the US economy during the Great Depression years when the Roosevelt administration began deficit spending in an attempt to put Keynesian theory into practice. The outcome was that the depression lasted until the war production began in the 1940's, creating real jobs through manufacturing.

Post-script, January 23, 2009: Mr. Quarter's viewpoint expressed above on the consequences that there may be a point at which U.S. debt load becomes so large that foreign investors will refuse to buy U.S. Treasury Bills/bonds is articulated in detail here in this WSJ article by Peter Schiff.

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