A Recipe For Failure... And America Doesn't Bat an Eye

As president-elect Obama has so diligently and strategically pointed out, America is due for a "significant recession." I suppose I could go on a tangent about how this recession came to be, but I'll save that epic novel for a later post. For this short blog I will expound on the methodology the next government plans on using to go about stimulating economic growth.

With the Fed again having interest rates nearing rock bottom and the economy still stuttering, it will no doubt be the federal government's fiscal hand that makes or breaks this recession. In two general terms, the government has two options of stimulating economic growth: temporary and permanent infusions. We are all-too familiar with Washington's beloved temporary infusions; most of us got one this past summer in the form of a $600-1200 check. These handouts did a little to increase consumer spending in the summer months. Congress and the president-elect have mentioned another temporary infusion much larger than the first. The goal of this infusion, again, is to stimulate aggregate demand and send the economy soaring into the 21st century. Some of the proponents of this use the first Bush stimulus package in 2002, which was very successful, to support their argument for another rebate check. What these politicians don't mention is that Bush's initial rebates were coupled with massive cuts in personal income and capital gains taxes, or permanent infusions.

Economic theory and graphs aside, let us just look at this from a common sense perspective. If you give an individual a one-time check, what are they going to do with it? Save it. Use it to pay bills. Maybe they'll spend some of it. However, if you sit the person down and tell them you are going to cut their taxes by 5% for at least the next 8 years, what are they going to do? The increased security and predictability of the permanent infusion will encourage the individual to invest that money into long-term assets like businesses, capital, employees, and best of all, financial institutions!

One of the problems in the economy right now is uncertainty amongst lenders over which prospective customers are worth the institution's investment. In the available-for-sale securities market between financial institutions, are these packaged securities really worth what they say they are? The government already took the wrong course of action in their $850 Billion & counting Bailout package in October, which did nothing to unfreeze inter-institutional trading and lending, because it did not remove the uncertainty of valuation from the securities that make up the balance sheets of these respective institutions.

Since we have failed to tackle this problem from the business-end, the government still has the opportunity to help fix the problem from the consumer end. A permanent infusion (tax cuts) will give consumers the extra cash flow to then infuse financial institutions with fresh loans for business expansion and new equipment. This form of infusion can work. Another huge temporary infusion may very well succeed in boosting consumer spending for one quarter and printing off even more money that we don't have, but it will not succeed in the ultimate goal of stimulating long-term economic growth. The president-elect saying this will be a "significant recession" is simply giving himself a cushion to fall back on when their next poor investment backfires.

The only problem with a tax cut is that it would require the government to cut spending and do with less, and the government shrinking in size and scope would most assuredly lead to a lapse in the space-time continuum and the implosion of the known universe.

My next post: The real problem with the Big Three