Santa is coming early this year, using his AAA credit rating to buy Americans gifts they didn’t request at prices they didn’t agree to pay. The method, stimulus, the funding, Treasuries, and the result, crowding out. For Americans in search of a mortgage this is troubling news.
In a typical economic downturn, where aggregate demand falls short of supply, the Keynesian solutions that President Obama employed in the Troubled Assets Relief Program (TARP) and the American Recovery and Reinvestment Act (ARRA) would probably succeed; government spending would stand-in for the absent consumer, and a rise in inflation and interest rates would go largely unnoticed.
This recession, however, wasn’t caused by a lack of demand. It was caused by the skyrocketing interest rates that stemmed from the financial crisis—interest rates that prevented people from buying new homes and businesses from stocking shelves, something that they do by purchasing goods on credit, selling them, paying back their creditors, pocketing the difference, and refreshing the cycle.
When banks stop offering corporate loans, other businesses can’t buy goods, which means they can’t earn money. When unemployment jumps, people fear the worst, and so the personal savings rate rises indicating a drop in aggregate demand. Two months later, Uncle Sam flies to the North Pole to redeem a favor.
The danger with this kind of stimulus—where ARRA infrastructure programs seek to raise the employment rate and with it consumer demand—is that its method of funding could drive the recession. Because the federal government lacks the money to pay for TARP and the ARRA, it has been auctioning long-term Treasuries to finance its stimulus, and since it has been trying to sell so many to a limited number of buyers, the Treasury has needed to offer higher-than-normal yields to unload all of them.
This hurts the economy in two ways.
First, higher yields on Treasuries are intended to make them a more desirable investment. While that means people might use unused money to buy them, thus funding the stimulus, it also means people, fearing market volatility, might move money from stocks to Treasuries; this slows the recovery of the market, and could lengthen the recession.
Second, high yields on Treasuries crowd out private lending. Treasuries are by design low-interest, low-risk loans. But when the yield rate rises, they become medium-interest, low-risk loans. As a result, banks buy Treasury notes and bonds instead of providing loans to businesses and families that don’t have the untainted two century credit history of the federal government. Of course the allergy to risk that has developed in the financial system only exacerbates the flight to Treasuries.
In the long term, this makes for higher interest rates on mortgages and higher interest rates on bridge loans to businesses. If these interest rates get high enough, people won’t buy homes and retailers won’t stock shelves: the triggers of the recession reemerge.
Indeed, Mr Obama and the 110th Congress have correctly recognized that the economy needs government intervention—specifically stimulus in construction and real estate—if it is to recover before 2010. However any fiscal stimulus ought not to undermine the recovery of private lending. It may be politically painful, but Congress will most aid long-term economic growth by funding its stimulus with income tax hikes.
Not only would higher income taxes discourage people from working multiple jobs, thereby opening more work to the unemployed, but they would also help create a broader stimulus—since the government regains a greater percentage of salaries paid to ARRA workers, it can sponsor more infrastructure improvements and employ more Americans.
Otherwise Mr Obama’s next biography may take a more unfriendly look into the power of audacity—namely how it can drive an earnest attempt at saving the economy into a fiscal race to destroying it.
-David Lamb and Nicole Adams
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Instead of spending money on expanding government (ARRA) and reforming “health care,” Obama could easily have cured the economic woes by lowering taxes (especially corporate), cutting spending and fixing the real problem, which is Medicare. Instead, he’s making every problem worse through more government. Remember, government caused both the so-called health care crisis and the real economic crisis through its economic interventions (i.e., Medicare and affordable housing). Government has no clue or mechanism to solve what it created except by uncreating and/or fixing what it screwed up in the first place.
This is one more indication of an administration eager to weigh popularity with actual economic benefit.
Check out what’s going on with Paulson and Bernanke. People are upset at the treasury and theyre not shutting up about it.
[...] Lamb presents When Treasuries Crowd Out Lending posted at Killer [...]
[...] "When Treasuries Crowd Out Lending" Originally published: 23 June 2009 Submitted by: U.S. Common Sense Summary: Looking at the drawbacks of the government attempting to "stimulate" the economy in this current recession. [...]