Japan, China: Thank Obama for the stimulus plan

Redbull313, you are in the US - Your response please.



Jan 16, 2009
Obama's stimulus plan - for China
By Hossein Askari and Noureddine Krichene
The United States has gone deeper into recession with the loss of 524,000 jobs in December, bringing to 2.6 million the total job loss for year, the largest annual total since World War II, and pushing the unemployment rate to 7.2% of the labor force.

The Congressional Budget Office is predicting a contraction of US real gross domestic product by 2.2% in 2009, unemployment to rise to 8.3%, and the US fiscal deficit, excluding president-elect Barack Obama's stimulus program, to widen to a record $1.2 trillion, or about 8.3% of GDP.

Obviously, the Troubled Assets Relief Program (TARP) has failed to deliver what Treasury Secretary Henry Paulson considered to be the best alternative for American families, forcefully convincing Congress that the monumental $700 billion plan would pull the economy out of recession. House speaker Nancy Pelosi's $165 billion stimulus package in 2008, a housing package of $300 billion, and massive bailouts (of Fannie Mae and Freddie Mac, insurer AIG, the auto industry and on and on) have failed to deliver the expected quick turnaround in the US economy.

Massive liquidity injections by the Fed - which pushed its assets to $2.2 trillion, pulled down interest rates to zero-bound and expanded money supply (M1) by 37% in 2008 - have only turned out to be self-defeating.

There is no explanation for this dismal performance and rising social cost of unemployment, except Fed chairman Ben Bernanke's aggressive policy, and that of Alan Greenspan before him, which has caused a collapse of the financial system and consequently a collapse of the stock market, with the Dow index falling from 14,164 on October 9, 2007 to 7,552 on November 20, 2008 for a decline of 47%.

Despite early warning signs since the breakout of the financial crisis in August 2007 in the form of a widespread credit freeze, exploding oil and food prices, food riots and energy protests, a depreciating dollar, and rising unemployment in the US, Bernanke has been adamantly determined to unleash an expansionary monetary policy to fight a recession that he was all along initiating.

He must believe in demand and credit policies to provide free money to those who do not earn it to spend and to kick-start aggregate demand. In doing so, he stalled the economy, triggered economic recession and financial chaos and inflicted excessive fiscal costs in the form of gigantic bailouts and falling taxes. US policymakers remain supportive of Bernanke's policy, despite the chaos it has been causing, seeing in it a magic way out of recession without any need for painful adjustment.

Policymakers always support unsustainable fiscal and monetary policies until the cost of these policies become overbearing and outweigh considerably the cost of adjustment.

Reminiscent of Paulson's approach, Obama has put out an urgent $1 trillion plan economic recovery aimed at creating 3.5 million new jobs. Like Paulson's TARP, the plan has as of now little detail and asks for immediate and unconditional approval by Congress, claiming, as Paulson previously did, that without this plan the sky would fall and the US economy would stand to loose another 4.5 million jobs.

Obama' message is his desire to put the jobless quickly back to work. The catchwords are infrastructure and tax rebate. In spite of its laudable objective, the authors of the vague plan, mostly Harvard economic professors, have failed to provide a diagnosis of the US economy and the underlying factors that brought it to this recessionary state. Without this diagnosis, policy recommendations have no foundation.

They failed to analyze why earlier massive stimulus programs combined with unorthodox monetary policy and negative real interest rates have not yet delivered the long-promised turnaround, or what makes their plan different from others. The most difficult aspect of the plan is the financing of a record-shattering fiscal deficit exceeding $2.2 trillion in 2009. Have Obama's big-name experts explored the alternative of reviving the US economy through curtailing the fiscal deficit instead of exacerbating it?

A much lower deficit could lead to faster economic recovery than monstrous unsustainable deficits. Without truly understanding John Maynard Keynes, much of the media and academics have called Obama's plan a triumph of Keynesians economics.

While a diagnosis and sectoral analysis of the US economy are either scanty or totally missing in the present rush to action, it behooves us to address some of the most pressing macroeconomic questions: could the US economy sustain any further a combination of unseen expansionary monetary and fiscal policies? How could a projected fiscal deficit, exceeding $2.2 trillion, or 16% of GDP, be financed? Could the US economy grow out of recession with the federal funds rate zero-bound? Are demand-led policies still valid for the US economy?

Empirically, no economy has been able to sustain an overburdening fiscal deficit without ending with unmanageable public debt, a depressed economy and financial disorder. Economic history is replete with examples of the disastrous consequences of excessive expansionary fiscal policies, which resulted in high or hyperinflation, falling real output and rising unemployment.

Because of strongly expansionary demand policies under the George W Bush administration, US national savings have become very low or even negative. Low savings invalidate a basic assumption for a Keynesian expansionary fiscal policy and make the financing of the deficit from real domestic savings unfeasible. The only sound financing option would be foreign financing, as in previous fiscal deficits.

On the one hand and under this assumption, the growth of the US fiscal deficit will have a negligible impact on US real GDP; it will only increase domestic consumption, and as experience in recent years has shown, it will end up stimulating through the classical multiplier effect the economies of China, Japan and commodity-producing countries. In other words, Obama's plan will end up creating 3.5 million jobs outside the US, and only few jobs domestically.

On the other hand, if foreign financing were discouraged by ridiculously low interest rates and fears of an expected further depreciation of the US dollar, the fiscal deficit would have to be financed through monetization. This scenario would be the most likely and the most detrimental. If it materializes, it will trigger inflationary dynamics that will be difficult to control, with a depreciating US dollar and a rapidly falling real economy. In brief, inflationary financing would be a catastrophic and a costly failure of Obama's plan. It would propel the economy into a stagflationary mode and push unemployment to much higher levels than the currently estimated high-end rate of 10-12%.

There is no doubt that the Obama administration is inheriting possibly the worst financial mess in US history resulting from the Bush administration's lax and disorderly financial policies. Populist economics, however, that replicate these policies for another four years would be very costly for the US economy.

The economy still has great potential for recovery to regain its premier status in the world. For that, it needs appropriate macroeconomic policies. Obama should have the courage to clean the prevailing financial mess and stabilize the US economy so it can return to its growth path. A stabilization program supported with supply side policies that enhance competitiveness will achieve the employment creation of 3.5 million new jobs and will ensure that these jobs are indeed created in the US and not in China or elsewhere.

The most pressing priority of a stabilization program is to rein in monetary policy, contain the fiscal deficit within a manageable 3% of GDP and consolidate the banking sector. The freeing of interest rates will enable banks to quickly resume lending, take price risks and consolidate their incomes and reserves. Enterprises will be able to borrow and finance the most efficient and profitable projects that will sustain economic growth. Real savings will increase and so will real investment; and stock markets will recover.

Maintaining interest rates at zero-bound will force banks to hold largely government paper and will erode their incomes and profitability. At such negative real interest rates, banks can never extend long-term loans. Besides freeing interest rates, money supply growth has to be brought within a reasonable target of say 5% per year.

The private sector produces food, clothing, appliances, cars and all goods and services needed for survival and well-being. Expanding the fiscal deficit beyond a reasonable limit will absorb all available savings and may crowd out private sector investment, hence forcing a decline in private output and employment. This point has been rightly made by Hal Varian in an article in the Wall Street Journal, January 7, 2008, headlined "Boost Private Investment to Boost the Economy". Spending on infrastructure could be achieved through a restructuring of spending in favor of capital expenditure without necessarily increasing overall government expenditure.

Supply side policies are most indicated for sustained economic growth. Tax credits on new investment would encourage private investment. The US and world economies continue to suffer food price inflation. There is a pressing need to expand food production and increase competitiveness and competition in food processing and marketing industries.

The US has large deficits in energy. Policies for expanding energy supply and increasing energy efficiency would be favorable to economic growth. The US car industry suffers from a lack of competitiveness and innovation. Plans to produce energy-efficient and high-quality vehicles would create and preserve jobs in the auto industry.

The housing industry has been subject to unusual speculation and interference with price adjustment. Such interference could only prolong the housing crisis. The government should refrain from preventing an orderly adjustment of prices in line with market fundamentals. It could, nonetheless, acquire or construct low-cost housing for low-income families.


Hossein Askari is professor of international business and international affairs at George Washington University. Noureddine Krichene is an economist at the International Monetary Fund and a former advisor, Islamic Development Bank, Jeddah.

Korea is joining in ...

‘Time to Sell’ Treasuries, Biggest Korean Fund Says (Update1)
By Wes Goodman

Jan. 19 (Bloomberg) -- A rally that sent U.S. Treasuries to their best year since 1995 is coming to an end, South Korea’s National Pension Service, the country’s biggest investor, said.

U.S. government efforts to combat the recession will prompt the Federal Reserve to raise interest rates this year, said Kim Heeseok, who oversees $160 billion as head of global investments for the service in Seoul. The decline would snap a surge that sent the securities up 14 percent last year, according to Merrill Lynch & Co.’s U.S. Treasury Master index, as investors sought the relative safety of debt.

“It’s time to sell U.S. Treasuries,” said Kim, who took over as head of investments at the start of the year. “The stimulus plan may cause inflation. The U.S. will raise the benchmark interest rate.”

U.S. government securities headed for their first monthly loss since October after President-elect Barack Obama, who takes office tomorrow, said he will do “whatever it takes” to battle what he called the biggest economic crisis since the Great Depression. Obama is planning an $850 billion stimulus plan, on top of $700 billion approved by President George W. Bush.

Ten-year Treasury yields, used as benchmarks for corporate and government borrowing costs, will rise to 3.08 percent by year-end from 2.32 percent now, a Bloomberg survey of banks and securities companies shows. An investor who bought today would lose 3.3 percent including reinvested interest if the forecast proves accurate, according to data compiled by Bloomberg.

Two-year rates will climb to 1.43 percent from 0.73 percent, according to the survey, which gives heavier weightings to the most recent forecasts.

Higher Rates

The Fed will increase its target rate for overnight loans between banks to 0.75 percent by March 31, 2010, the poll shows. The U.S. central bank last month cut the target to a range of zero percent to 0.25 percent.

U.S. yields indicate traders are becoming more concerned about inflation.

The difference between rates on 10-year Treasury Inflation Protected Securities, or TIPS, and conventional notes, which reflects the outlook among traders for consumer prices, widened to 53 basis points from minus 8 basis points two months ago.

The spread has averaged 1.19 percentage points during the past six months.

Cutting Holdings

Investors in South Korea cut their holdings of U.S. debt to $28.6 billion in November, less than half of what they owned in 2006, based on Treasury Department data.

China, the largest foreign owner of Treasuries, increased its stake to a record $681.9 billion in November.

It may take a few months for the U.S. economy to start growing and Treasuries to fall, Kim said. Government debt has handed investors a 0.4 percent loss so far in January, according to the Merrill index.

The economy will shrink in the first half of 2009 and expand in the second, a Bloomberg survey of banks and securities companies shows.

“At the end of this year, Treasury prices will depreciate,” he said. “We are considering” selling.

To contact the reporter on this story: Wes Goodman in Singapore at [email protected].

Last Updated: January 19, 2009 04:00 EST