Flying Pink Unicorns

Andrew is absolutely WRONG. I don't get to say that very often. In fact, other than on matters Israel (where he sometimes is wrong) I almost never do. But he's 100% wrong this time.

We have traded a few e-mails about what the fed and Congress should do about the economy.

First things first. We are in recession, effectively. Whether we have 2 consecutive negative growth quarters or not (and we likely will) is really academic. The real question as far as most people are concerned is whether the economy has slowed sharply enough that people are losing jobs and feeling less secure in them, and whether wages stop rising/start falling in real terms (real means adjusted for inflation). And that's clearly the case.

Anyway, I asked him if he would support a second, HUGE stimulus package. The first one, you will recall, were the tax rebates. At around $150 billion I wouldn't call it small, but it wasn't HUGE. And it was only temporary. And much of it was probably saved, providing little stimulus. I opposed it at the time, favoring a LOT more spending, which is much more stimulative. But the democrats caved, and off we went. A lot of serious people (incredibly, the Treasury Secretary, Henry Paulson, is a serious person, though he's often reading from White House provided cue cards) wanted to wait before enacting a second stimulus package.

Well, the economy is headed down the crapper. The fed, just as I wanted, has cut rates VERY rapidly. In fact, it even went 25 basis points lower than I wanted. With the federal funds rate at 2% and headline inflation now above 5%, short term interest rates are sharply negative. The fed is pushing incredibly hard for the economy to get moving again. The last time real short term interest rates were THIS low for any real length of time was the mid and late 1970s. And that didn't end well. Inflation took off, the fed raised rates to the moon under Volcker, and threw the economy into a deep recession, on purpose, so as to stop inflation from getting out of hand. Painful as the early 1980s recession was (and it was PAINFUL), it was well worth the pain.

But back to the present. Rates are REALLY low, just as I advocated. The financial system is teetering, as you all likely know. A big bank failure in California, and, much more importantly, Fannie Mae and Freddy Mac are nearish to the brink. They will not be allowed to fail, no way, no how. Nor will any of the BIG banks-- Chase, Citigroup, Bank of America. I have long felt that if a BIG money center bank just flat failed that such a failure could pretty much unleash the four horsemen of the Apocalypse. Now yes that's an exaggeration, but nonetheless Citi or Chase failing would be a monumental disaster, could bring the financial system crashing down, which would cause a short term (at least) depression. Not recession, depression. Hence the four horsemen.

None of this will happen, but I point this out as background for why I pushed Ben Bernanke so hard to cut rates to the floor to begin with. To save the financial system.

Well, there are headaches, but that task has probably been largely accomplished. Which is why the fed will begin removing money from the financial system sooner than I had expected, probably in the early Fall. And then shortly after the Presidential election it will begin raising rates, and it won't be slowly. I've said this in an earlier post, but I'm moving up the timetable. The recent oil price surge (though it has come down $10) and inflation surge is absolutely scary. The fed is essentially certain to be raising rates next year, and fast, whether the economy is weak or not, unless its godawful.

Which led me to thinking about stimulus number 2, this time on the spending side. America's infrastructure (roads, tunnels, bridges, ports, rail, airport) has long lagged the best of the rich world. To be blunt, our infrastructure gets a D by the people who rate these things. We could productively spend many hundreds of billions over the next 3-5 years on it. Bridges, high speed rail (Amtrak is a joke), ports (I don't mean security Andrew, I mean efficiency), and so on. The GREAT thing about a massive infrastructure based stimulus package is that it would require the hiring of many hundreds of thousands of construction workers, some of the people hardest hit from the housing disaster. There are, right now, at a bare minimum a few hundred thousand (probably more) experienced constructions workers home unemployed or underemployed and waiting for the phone to ring.

I'm thinking of something in the neighborhood of $500 billion over the next 3-4 years. Above and beyond all the infrastructure spending we're planning. So it would be pretty big. I'd want it as front loaded as possible, but as a practical matter environmental reviews and other things take time, so we REALLY should start this immediately if it is going to have any stimulative effect in 2009 and 2010 as the sharply higher interest rates I predict begin to take hold.

I suggested this to Andrew, and he agreed, but said we shouldn't increase the deficit for it (as I am advocating), but instead should cut a ton of wasteful defense spending to pay for it. I replied that this would cancel out much or all of the stimulative effect. He was fine with that, seeing a recession as not the end of the world. THIS IS WHERE HE WAS SO WRONG. While a recession ISN'T the end of the world of course, and has useful positive aspects, if a person is unemployed today and wanted to work, that is a day of her labor that is gone forever, simply wasted. Its like leaving milk out of the refrigerator for 2 days. A perfectly good day's work, which would have added value to whatever company she would work for, and of course make her money, is lost forever. Unemployment really is a waste. Now I don't want to overdo this point, because as I said there are salutary effects to recessions; as they force businesses (and sometimes governments) that are not spending wisely to shape up. GM is trying again. Etc.

But Andrew is precisely WRONG to mildly oppose a stimulus package right now. As in the late 70s/early 80s, the fed next year and the year after is going to be raising rates. This will SLOW economic growth late in 2009 and early in 2010. This likely slowdown will likely be most unwelcome, as I doubt seriously the economy will be rip roaring strong by then. Increasing the deficit for the next 3 years, significantly, to pay for investments (a good majority of what I propose will be useful investments, even after the Bridge to Nowhere Congress gets through with it) will be a useful counterweight to the coming fed fight against inflation. This is the point Andrew misses.

Now cutting wasteful defense spending may well be worth doing in its own right, that's beyond the scope of this post. But if you did it I would advocate replacing much of that money with increased spending elsewhere (education, perhaps health care in the short run), or tax cuts for the middle class and working class and poor. I am perfectly willing to run up the deficit next year and the year after, high though it will be, to give the fed room to raise rates to prevent the possibility of another inflation outbreak. Inflation doesn't keep me up at night, and as we can all see, it really doesn't keep Ben Bernanke up at night either. But given the coming interest rate hikes, I have laid out the steps we should take to prepare on the fiscal side.