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An Economic Wrestling Match For Our Future

December 14th, 2009 Michael McDonough

As the invisible hand of the market continues wrestling the imprudent hand of governments; consequences will be felt across the globe as one hand hits the table…

Government stimulus and monetary policy has undoubtedly led us out of one of the worst recessions since the Great Depression, but what impact will these policies have on the future?  Many economists agree that the current growth period has been significantly bolstered by fiscal stimulus, which has failed to substantially address a lack in final demand and create what many would consider to be a sustained recovery.  Let’s take a look at this chart published by Goldman Sach’s chief economist Jan Hatzius depicting his firm’s view on the medium term impact of the fiscal stimulus package on GDP:

GS Fiscal Stimulus on GDPSource: Goldman Sachs

Not pretty, especially considering there are no indications that final demand is prepared to take the lead as this recoveries growth engine.  Given the nature of politics and the election cycle it makes sense for some politicians to be more concerned over short-term outcomes versus long-term consequences, at least if they want to retain their jobs.  And who wants to be unemployed right now?

Funds for the government’s stimulus package do not just appear; they were borrowed.  Not only were they borrowed, but they were borrowed at teaser rates subprime Vegas home buyers would have been happy with several years ago.  It is my belief over the long-term the government’s soaring debt load combined with an eventual increment in rates will lead to substantially higher taxes in the US and lower growth prospects for the country.  What we have done is borrow from future growth for the gains we are realizing today.

Turning to the central bank, copious amounts of liquidity have been poured into the financial system to help stave off deflation and support asset prices.  These funds have not yet triggered significant inflationary concerns, because they have simply made up for a slowdown in the velocity of money.  What I mean is the fed’s injections counteracted an essential halt in lending markets; making up for borrowed money that would have existed to prop prices.  But, this also means that as banks turn back on the lending spicket excess liquidity in the system can quickly turn into fuel for inflation.  This will force the Fed to react by withdrawing liquidity from the system, and hiking the target rate.  The big question will if the fed can remove excess  liquidity faster than inflation can take root, and if so will unemployment still be at uncomfortably high levels?  Probably.

All of these questions will be answered in time, but I have no doubt we will be paying for today’s growth well into the future.  Will it be worth the price? We can only hope.

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