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Why the Obama Stimulus Unfortunately Won’t Work January 30, 2009

Posted by neoavatara in Economy, History, Politics.
Tags: , , , , , , ,

I hate to say this, because I honestly believe President Obama is well intentioned.  But the stimulus package, in the current form, is likely to not accomplish anything, other than growing the national debt.  But as more pressure from Democrats and the media is brought to bear on Republican Senators, I think we should start a real debate on whether this stimulus package will work, which is ultimately what we all want.

Why do I state this?  Because of history.  We do have historical parallels to compare to, although the Democrats would rather skirt over those issues than actually have a debate.

Japan 1985-Present

In 1985, Japan was at the height of its economic prowess.  Some economists were talking about Japan surpassing the U.S. as the world’s economic superpower.  Than, they hit a roadbump.  Largely because of the appreciation of the yen, Japanese exports started to stagnate.  Real GDP during the 1990s stagnated, rising only from 428,826 billion yen in 1990 to 469,480 billion yen by the end of 2000. Growth has been negative since 1998. The unemployment rate rose from 2.1 percent in 1991 to 4.7 percent at the end of 2000. Although the unemployment rate may seem low by international standards, the rise to 4.7 percent is significant in Japan, given the cultural and historical precedent of lifetime employment and given that it was never above 2.8 percent in the 1980s.

In other words, bad.

But here is the rub.  The Japanese government did respond.  From 1990-2000, the government passed 10 stimuli plans, primarily INFRASTRUTCURE AND JOBS PROGRAMS (sound familiar?).  Between 1992 and 1995, Japan tried six spending programs totaling 65.5 trillion yen (about $700 billion).  The discount rate was cut to 0%.  When all this didn’t work, they tried massive tax cuts in 1998 and 2002.  Nothing worked.

The Austrian School of economics comes closest to understanding the cyclic failure of the Japanese economy.  Japan has experienced an Austrian business cycle. The initial boom was created by a central bank-induced monetary expansion. Because of repeated interventions, the economy has not recovered. The greatest malinvestments took place in capital-intensive industries in the earlier stages of production. For Japan’s economy to recover the government must stop intervening in the economy and allow the market process to realign the structure of production to match consumer preferences.

The American Great Depression of the 1930s


This was  the story of ineptitude piled on to stupidity.  Herbert Hoover was an extremist laissez faire economy believer.  Except when he felt like raising taxes during the greatest economic downturn in U.S. history.  That is right, he raised taxes as the great depression started.  Then, FDR repeated the tomfoolery, and raised it again (double down!).  Of course, FDR also massively increased government spending, which didn’t help the economy that much, but did keep people alive.

Second was the lack of understanding of the world economy.  In 1930, America enacted the Smoot-Hawley Tariff Act, which raised taxes on international trade. The idea was that protectionism would be good for American jobs and American tax revenues. But other nations retaliated, and the volume of global trade collapsed. It took more than 50 years for the percentage of world GDP contributed by global trade to recover to 1929 levels.

And maybe worst of all, in 1930 the Federal Reserve, in a Hooveresque laissez faire move, did not intervene to save banks from failing.  This of course started the vicious cycle of lack of confidence in banks and the financial system, which only further weakened the economy. Additionally, they did not lower the Fed loan rates, therefore stifiling the oxygen that drives the market, free flowing money.

FDR did what he needed to do, which was keep the country going at all costs.  If he had been in power in 1930, his policies may not have been the right ones.  However, he had little choice with unemployment pushing 25%.  However, it did stifle the economic recovery.  Free market growth was nonexistent until after World War II.  The GDP grew, but only by government growth.  And that ultimately cannot be sustained long term.  By 1937, the U.S. entered another signficant recession, losing 6.8% of GDP in a single year, only to be ‘rescued’ by the War.

Remember, unemployment when Roosevelt was inaugurated was 23%.  By the start of his second term, unemployment was still at 14%, with the 9% that were employed in the interval almost wholly coming from government jobs; there was no economic revival to be seen. And by 1938, unemployment jumped back up to 19%…only to drop during the war period.

Now, let us put the current recession in perspective:


Which tells us what?  That this recession is certainly bad, and will get worse, but it is not yet in the realm of the worst post War economic downturns.  Yet.

End Game?

So, after all of this gobbledygook, what does this tell us?

First, it tells us the first lesson of a financial crisis is stabilize the problem.  In this case, the problem was the financial liquidity freeze occuring because of the massive amount of bad loans that were failing, primarily in the United States, but also through out Europe and Asia.  The massive Troubled Assets Relief Plan (TARP) appears to have done that, with relative stabilization of the banking industry, and the beginning of the thaw in the loan freeze.  The TARP was an inelegant sledge hammer, to be sure, but it appears to have met its goal.  Second, the Federal Reserve and the Federal Governement did what they can.  The Fed lowered interest rates.  The goverment through Federal Deposit Insurance Corporation (FDIC) built confidence in the public that their money was safe in banks, and thus prevented a run on cash.

The question really arises whether there is one crisis left:  the housing crisis.  Will the rising mortgage failure rate stimulate one more crushing force on the financial markets?  And will the government have to somehow step in and stabilize this problem?  Ironically, John McCain suggested exactly such a thing during the Presidential campaign.  So far, the Obama Administration seems reluctant to do anything of the sort.

Next question, however, is the more difficult one.  Stabilization is easy, because in an emergency you throw money at the problem and stop the bleeding.  But in the recovery period, you have to rebuild a sustainable market for long term growth.  That is the key to economic recovery.  Government expenditures, such as in the Great Depression and the Japanese recession, are excellent at limiting the public’s pain, by giving support financially where it is needed.  But as in the 1930s, it by no means creates any market growth, as we can see with the failure of private sources from creating jobs during that period.

The reaction to the Japanese recession speaks volumes.  It in many ways has greater similarity to the current recession than the Great Depression.  With decrease money flow, failing exports, and increasing unemployment, how do you rebuild an economy that is based on consumerism?

Clearly what you don’t do is just increase government expenditures blindly, because they clearly create no growth, while increasing government debt.  Second, if you are going to cut taxes, you must do it early.  Otherwise, you compound the government debt in later years by decreasing government procedes by increasing tax cuts.  Third, you must stabilize the market issues that are limiting growth; in this case, the banking crisis and toxic mortgage issues, so the market can move past the current issues.

Additionally, another lesson is that no matter what you do, the public will have to suffer pain.  That is just the reality.  The government’s job is to lessen the pain as much as possible.  But job losses will come, and the market will contract.  Growth can only occur after a painful retraction.  Trying to stop the retraction just prolongs the pain.

My issue with the Obama stimulus package, as it stands, is that it follows the Japanese recovery plan of 1990 to a T.  It is almost the same package, almost a similar size, and with similar small tax cuts.  Sure, the Japanese plan was likely to slow and too small initially, but its overall constituency and size was similar.  Why it should succeed, I have no idea.

Additionally, many Democrats had hoped that Mr. Obama’s good will alone would lift the markets.  That certainly flew in the face of reality, and is now clearly not the case; this was the worst January for the stock markets ever.  And there is no good in the economy at all.  And to make matters worse, Mr. Obama himself is talking down the economy.  As much as pundits talk down upon the concept, psychology is an integral component to the health of an economy.  And right now, we may not be in an economic depression, but we are certainly in a psychological one.  And having President Obama come on air every day and saying things are going to be even worse certainly can’t help.

So though the ‘debate’ will continue (and I have hearrd little real debate, other than the crisis is so bad we can’t discuss anything, we just have to act blindly…).  Although, passage of the bill in the Senate is now atleast slightly in doubt, and more debate may come simply because of this reality.  The economy may recover, but it is questionable whether this stimulus package will have anything to do with that recovery.



1. Eolirin - January 30, 2009

You’re reading some of those stats wrong.

That collpase in ’37 was when FDR reduced government spending and tried to balance the budget. An economy in that much trouble takes a long time to recover. It hadn’t gotten to that point in 37 yet, and that reduction in spending tanked it. The post War boom was, on the other hand, mostly fueled by optimism having won and the fact that people now had money from the near 100% employment that occurred during the war (and that was government sponsored too. War time production was in effect a giant works program), and they couldn’t really spend on much while the war was on. Once a lot of the restrictions and rationing ended, money got poured into things like houses and cars and there was a sharp economic upturn.

There’s also a really strong argument that the Japanese stimulus plans were too slow in coming and too small individually. They didn’t try to help their banks recover until 7 or 8 years after the initial slump, and their attempts at public spending were ultimately done in fits and starts even if the overall value was high. It was too little, too late, spread too thinly over a period of time. Despite that, the stimulus did help; every time they used it there was improvement, and when they tried to balance the budget in 97 they went into an immediate down turn.

The root of the problem comes from the fact that people are afraid to spend money, and in a situation like that, no matter what changes you make to the fundamentals you’ll never recover; if no one else is going to spend money, it doesn’t matter what the market situation is, either the government steps in or you end up with a self-reinforcing cycle of unemployment. So even if you fix all of the broken market bits it’s mostly moot if people aren’t investing or buying things because they’re afraid of the overall outlook. Japan fell into a psychological trap where there was no real sense of hope for an economic recovery; people started working under the assumption that things were not going to recover any time soon, and so they became extremely conservative in their use of money.

That conservative behavior on an individual level was what caused the lack of recovery more than anything else.

neoavatara - January 30, 2009

No, I am reading the stats right.

You are absolutely right about the downturn in 1937. But step back. After 4 years of the largest spending in American history, the free market was not in any way ready for the government to reduce spending. Doesn’t that worry you? In other words, the government didn’t fix the free market system at all. It was running a socialist country. Now, there is a legitimate argument that FDR had no choice; but is that what we want from the current Obama stimulus package?

And I agree war time is nothing but a big jobs program. But post war, the reason for expansion was clear: we were the only country with significant capacity to build. It was a peace dividend, and also a boon to countries that hadn’t been ravaged by war. In 1950, we were more than half of the world’s entire GDP.

The Japanese stimuli likely were too slow to come. No doubt about that. But in the initial phase, which was 1992-1995, they spent almost $700 billion; we are going to spend, with TARP, around $1.9 trillion for an economy more than twice as big as Japan’s. And Obama’s own people said the money will not be spent until 2011 completely, which means a 3 year window. You will have to explain to me what the difference is.

The root of the problem is not people spending. It is that there is no faith in the marketplace. People see their homes devaluing. People are losing their homes. Stock values are falling. Where is the safety? Until home prices level off, there can be no recovery, which means that the mortgage crisis must be faced first, if you are looking for an individual recovery. Otherwise, the only intelligent behavior for individuals would be to be very conservative in their spending, which will slow the recovery even further.

2. SAM - January 30, 2009

All this is chicken or the egg theory. America spent and spent and spent and got greedy for more. We cut our selves up and bled out, now we have to heal. Yes the Gov. will have to spend our precious taxes on sowing up our self inflicted wounds.

The money that is proposed will be the tip of the ice burg, as Bush spent several Trillion on war, Obama will have to spend even more to re-align our country.

Our infrastructure is old and antiquated, our schools are in decay, our hospitals are on the verge of collapse, no thanks to the corporate world where double digit profits was more inportent than clean air. Not a bright future we’ve made for ourselves.

Obama will make mistakes but focusing on his inadequacies will only hurt ourselves and delay what needs to be done, more than anything we need a leader to look up too, to bring us back in line with good morels and ethics.

We will have to pay back what we barrow but with out proper a education, health care and a functioning infrustructure our country will fall apart and feed upon itself.

neoavatara - January 30, 2009

Like I said, I think Obama is well meaning. But we should have a real debate if what we are doing is really going to help, and that is not happening. If the money proposed is the tip of the iceberg, I don’t want to look underwater. The Obama budgets will add more to the deficit in 2 years than Reagan did in 8. If you are saying there is more spending coming, I don’t know how we will stay afloat.

3. Broadway69 - February 1, 2009

Hmmm, some good points here but two comments. Firstly I couldn’t agree more about tackling the mortgage mess first. I am, however; severely disappointed in how this could play out in parallel to the bank bailout. With the greediest, guiltiest individuals being handed government money to get themselves out of their own filthy mess. I paid my crappy ARM on time for almost 4 years. I made sacrifices to pay the mortgage and in the end; the only people who will get relief have to be a minimum of 2 months delinquent? I’m sorry, so being a responsible borrower gets me what? An F U with a side piss off?

Secondly, your kinda wishy-washy on your position on government propping up the economy with cash injections. You mentioned Obama’s plan has good intentions and the Japanese plan had some success despite its shortcomings; however, you fail to provide a solution for the problem outside of pointing out what will not work. In the end, do you or do you not support the notions of government spending programs creating jobs and fulfilling a much needed infrastructure re-build provided the primary problem you identified (toxic mortgages) are addressed?

neoavatara - February 1, 2009

In times of recession, government must provide a safety net. That includes unemployment, food stamps, possibly health care for the indigent, and work training programs. As for ‘shovel ready’ jobs, they have never proved to stimulate the economy. I would favor them in place of unemployment benefits, just to keep people afloat, but have no misconceptions that they will actually help shorten the recession. Government certainly has the primary role in infrastructure, but I think that is a slightly separate issue. When the two issues overlap, I don’t mind infrastructure spending. However, much of the infrastructure spending in this bill will not be spent for years; way too late to help anyone now unemployed.

4. larry - February 1, 2009

For those who oppose the president’s plan, assuming you agree that doing nothing, is NOT an option…..what would you suggest?
My own opinion is that the FDR approach is, even though I am also concerned about our out-of-control national debt, is the way to go, simply because the problem is to large to try to solve it “on the cheap”.
Will it work(?), who knows for sure, but one thing is for sure (again, my humble opinion)….We have to do something, and I’ve heard of no other viable alternatives.
One thing seems apparent, at least to me…..tax cuts will have be off-of-the-table for at least the for see able future.

5. gorbachav - February 1, 2009

I’m of the opinion that the hidden driver behind the Economy’s collapse (if it is indeed collapsing) is that consumers have less incentive to consume than at any time in the past 60 years.

I think there’s a cultural rejection of consumerism going on, and the industries which have fed our consumerist instincts are now witnessing the resultant dramatic drop in revenue.

New business models will need to be developed. Apple can’t keep releasing new Ipods every year and expect the same level of demand. Nor should car industries expect two-person households to need 4 cars. How many cellphones have we each individually owned in the last 10 years? I’ve had 6. That’s funny, because 10 years ago I didn’t even need one, but I’ve had 6 in a decade? What a waste! I think we’re all getting wise the scam.

The only real solution is the one nobody wants to admit. Housing prices have to come WAY DOWN. People under 40 predominantly work in the service industry, and service industry incomes cannot drive the current housing market. If housing prices ever fall to within reasonable grasp of service sector incomes, then a huge proportion of the workforce which was shut out of home-ownership will start buying homes. And if they have any money left over at the end of the month, the new home-owners will also invest in new furnishings and technology for their homes. Which will in turn lead to economic stimulation.

But, the average home price will have to shrink to around $85,000. And that means a bunch of baby boomers are going to lose their precious nest egg. Also, as people start buying low-priced homes, the market will immediately respond by increasing prices. So, the goverment would have to step in to regulate the cost of housing to keep prices low.

Another big problem nobody is paying attention to is the lack of reliable family structure, and how that’s impacting markets. Housing prices have always been based on multiple income families. But with divorce rates at 50%+, the number of multiple-income families are dwindling. You can’t bank on them anymore.

Furthermore, multiple generations used to work together to help each other make the big purchases. Parents used to help their kids buy a home. And parents lived with their adult children. Brothers and sisters could be relied upon to help out in a crisis. Today’s western culture has been so thoroughly debased by TV addiction that family bonds have been severely strained. And that’s made our system unsustainable. (I will also take this moment to point out the remarkable successes of Southasian immigrant communities as evidence of the power and value of strong family cohesion.)

neoavatara - February 1, 2009

I disagree. I wish you were right, but I just don’t believe. It is this simple: People don’t have cash burning in their pockets. If they did, they would spend it. This is just another business cycle.

6. RA Chinn - February 2, 2009

Looking for details in the stimulus package that directly address jobs. I have felt that housing has been allowed to increase based on paper – ARMs financing based on expectations of appreciation, the housing market get rich schemes house flipping, buying with no money down, refinancing solely for interest rate advantage, completely exploited all available money in the housing market, to the point that property prices now exclude buyers from affording associated necessities of ownership (furnishing, maintenance, improvements).
The stimulus package focus on infrastructure should also allow a basis for financing for construction industry and related business activity, possibly even heavy industry. I don’t know if it does.

Skepticism of the critics of the stimulus package is justified unless they can specify better alternatives for producing jobs long term.

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