THE STIMULUS BASED ECONOMY

12/15/08

 There will be no sustained economic recovery until asset prices decline to the point where they are once again in line with incomes. But what happens when this occurs at the same time the Govt. is flooding the economic system with cheap and easy money and also stimulating economic activity with massive Govt. spending increases? The answer is the same as the last time this kind of fiscal policy was pursued: yet another bubble based economic boom. The Govt. is saving us all from poor Govt. and Fed fiscal policy by feeding us massive amounts of the same poor policies that started this mess to begin with.

 To date, including all Federal Reserve liquidity boosting programs and all of the various bailout efforts and stimulus packages, over $7 Trillion has been pumped into the system to prevent a collapse. This is going to continue. The Obama administration that is taking shape is already promising a new stimulus package that will dwarf the $168 Billion handed out this past spring. Numbers as large as an additional $700 Billion are being discussed. In addition to this, the existing TARP bailout effort is going to be expanded from $700 Billion to $1.2 Trillion and dozens of smaller individual bailout programs are going to be passed out to various companies and industries including large banks and automobile manufacturers  (Citibank just received over $40 Billion in direct funding through this type of tailored bailout). The Federal Reserve has just announced plans to issue guarantees for up to $7.4 Trillion on portfolios of toxic mortgage related assets in the books of all the major financial institutions. Citibank is the first recipient with over $300 billion in such assets now guaranteed by the Fed. The Fed has also announced an additional, new package of $800 billion that will be used to buy new issuances of Mortgage Backed Securities and consumer debt based bonds in the open market in order to promote additional lending and push interest rates lower. In effect, the Fed is now acting to directly subsidize mortgage rates!

 With the Govt. set to pump literally $$$$ Trillions into the economy through various additional bailout and stimulus efforts, what kind of programs are we likely to see?

 Among the most interesting plans is a housing bailout. This is likely to take the form of additional subsidized interest rates and expanded low-income home ownership programs. A big part of the $700 Billion second stimulus program is expected to be aimed directly at supporting the housing market including sustained Federal Govt. subsidizing of interest rates on 30 year fixed rate mortgage programs. This could lead to interest rates on such loan programs as low as 4%. Clearly, that would be a huge positive for the housing market.

 Another key aspect of the coming economic rescue packages will be a program aimed at maintaining home ownership rates among low income and minority households. This has been a Govt. focus for the past 40 years and I believe the Obama administration is highly unlikely to sit idle while minority homeownership rates plummet back to early 1970s numbers. Instead, we will see the expansion of FHA loan programs designed to aid such homebuyers. This will include Federal tax credits for down payments and the return of $0 down payment FHA loan programs for low-income buyers.

 With asset values back below where they were before this boom began and a fresh round of massive Govt. economic stimulus beginning to take effect I do believe we are likely to see a broad economic recovery begin by late 2009 to early 2010. This recover is likely to grow rapidly and could be very strong. In fact, given the scale of the intervention efforts I fear another bubble could easily form and we are likely repeat this mess in a few short years.

 All of this economic stimulus and bailout does not come without risks. The longer-term implications are going to be rooted in very high inflation. Moving forward, this is going to be very dangerous and it is a prime reason why I am focused on investing in hard assets that are inflation protected.

 The Govt. and Federal Reserve are clearly going to pump currency into the financial system and drive economic activity with increase Federal spending on whatever level is going to be required to generate economic growth. Regardless of whether we ultimately see a recovery begin purely because asset values and prices have declined to the point of again being in line with income or if the bailout efforts succeed in driving lending and borrowing back to boom levels the one result which will be the same is DEBT. All of these bailouts are going to combine to cost Trillions.

 Where is this money going to come from?

 It is not going to come from taxes, at least not anytime in the next couple of decades. We have been running real annual budget deficits of over $500 billion per year and fiscal 2009 is already projected to exceed $1 Trillion. Even if taxes are raised substantially and all of the Bush tax cuts are eliminated completely the increased revenue would not begin to balance the Federal Budget much less meet the additional costs of these bailout efforts. Additionally, Baby Boomers will begin to retire en-mass in 2011 and Federal expenses associated with Social Security, Medicare and Medicaid are going to explode. There is absolutely no mathematically viable formula through which all of this spending can be paid for through increased taxes.

 It also cannot be funded through borrowing. The US is already over $10 Trillion in debt. This is a figure that is hard to comprehend.  $10,000,000,000,000.00    That is 13 zeroes not including the cents. That is enough money that if you stacked it in $1000 bills the pile would be 670 miles high. It means that every man, woman and child in this nation owes roughly $35,000. If your married with 2 kids….  Your share is now around $140,000.

It took the Govt. over 220 years to accumulate debt totaling $6 Trillion. We added another $4 Trillion in just the last 8 years. With the bailout programs and entitlement program shortfalls, we will likely double the debt to over $20 Trillion within the next 5 years. This is more money than the entire planets excess savings.

 Even if the entire rest of the planet wanted to invest all of its long-term savings into buying US debt, it would not be enough to keep up with the debt requirements this nation is going to generate over the next 25 years. It is a simple reality that the financial plan this nation is following cannot be funded through tax revenue and it cannot be funded through borrowing. It can only be funded through one means: Expansion of the money supply. This means “Printing Money”.

 This is already happening. The Federal Reserve does not have the assets to fund all of the bailout programs and guarantees that it has issued and promised. It is meeting these obligations through the expansion of the Fed balance sheet. This is printing money.   When this is done on the scale that is currently being pursued it never ends well. The result down the road is going to be rampant inflation and the possible destruction of the dollar as the worlds reserve currency. Funding our spending needs through printing money is not a viable economic model!

 When I sit back and try to think objectively about the broader economic picture, it is clear to me that there are no risk free investments. Even hoarding cash and burying it in your yard can result in huge losses if the monetary system is devalued. The bailout and stimulus package based economy that we are moving toward certainly brings with it huge risks. We may get a another short term bubble but ultimately I believe we may see inflation rates run in the high double digits and ultimately the dollar could be devalued and lose its status as the world’s reserve currency.