Stimulus 101

The word "stimulus" is defined in the dictionary as: something that incites to action or exertion or quicken action.... In economics, or the business world in general, the word stimulus is used to describe the act of government pumping money into the system to incite to action an otherwise sleepy economy where lenders are hesitant to lend and businesses and consumers are unwilling to borrow and or spend. The reasons an economy goes into contrition mode are many but chief among them is lack of credit/liquidity or the demand thereof. So the recent action by our government to pump nearly three trillion dollars into the economy no doubt was intended to alleviate the credit crunch and therefore cause a multiplier effect that is supposed to kick start the economy. This sounds great in theory but did not work and will not work for this current crisis.


First let me refute the opinion that the stimulus has actually worked. Those of that opinion basically site two examples of how or why the stimulus has been effective. Example one is that because of the stimulus we have saved roughly 650,000 jobs. This number is derived as the difference between the monthly job loss in January '09 of 779,000 and last month job loss of about 125,000. Example two is that without the stimulus we would be in much worse situation (or at least we could be). There is no doubt that the rate of job losses has fallen from its high and the administration has not wasted a moment to credit the stimulus package for that drop. Yet they can't tells us where or how these jobs were saved. I, on the other hand, will at least offer a theory as to why the decline in job losses has nothing to do with the stimulus. The theory is based on something known as the inventory buildup cycle. There is a natural process that takes place when economies are in recession. In that process are built in safety measures that may, later on, be breached but in an orderly manner (if there is such a thing in fast worsening economies). I am talking about the initial reaction of businesses at the beginning of this crisis, or any crisis, and that is the draw down of inventory to dangerously low levels. Once those levels are reached businesses face a critical decision even in the face of a still deteriorating economy. Unless they resume their activities (for which they were created) they risk going out of business, literally. So the natural act is to stop the firing and start building up their inventories for when the sun shines again. Hence the drop in job losses. However, unless those inventories make their way to the final consumer job losses could accelerate again. The stimulus money could not have had a positive impact on job losses because for the most part that money never made it to the segment of the economy that actually effect the kick start. As a matter of fact a large chunk of that money remains at the Fed and the Treasury where it was created in the first place stimulating nothing but political grandstanding.


The part that made its way to businesses or consumers was mostly a disaster. Billions were spent on propping up the housing market hoping to limit and reverse the foreclosure trend. At least that is what we were told. Funny thing is that the exact opposite has happened. Home prices are still declining and foreclosures are projected to be higher that the 4 million of 2009 . According to Forbes magazine as of July 1, 2010 one third of all homes for sale have seen their asking price lowered by an average of 10% (Phoenix being the worst at 13%). Some investment!!


As for the money that has so far kept the banking system afloat, I do have to say that at least some of it has actually been a great investment for the Treasury as evidenced by the return the government has received from the sale of various options that it had in some of the banks. But it did nothing to stimulate the economy because the banks are not lending. Here is the problem though: the government didn't actually have to print that money to get the interbank market pulsing again. All it had to do is come out and give its explicit guarantee as a backstop for the interbank market. Other stimulus programs such as cash for clunkers and the bailout of GM and Chrysler didn't fare any better.


There is another portion of this stimulus that simply shifted the losses from the private sector to the Fed's balance sheet. So instead of private shareholders taking the hit for the assumed risk now you and I have to pay for that, again doing nothing to stimulate the economy.


The suggestion that we could be in worse shape but for the stimulus may be right, although , again just like in saving jobs there is no evidence to support that. In fact, I argue that this is our way out of this mess. In other words our problem few years ago was too much liquidity and easily available credit to worthy and unworthy consumers alike. Of course I am not suggesting that all credit be cut off, but we also don't want to pump so much money into the system that the end result would be an inevitable return to the easy money of a decade or so ago. And that is exactly what will happen when that stash of cash makes its way to the economy.

Until we work through all the excesses we have and as long as the consumer is overwhelmed with debt (total households debt is 90% of GDP) the economy will not recover no matter how much money is pumped into the system. The simple fact is that government does not buy everyday essentials. The consumer is too busy deleveraging and businesses are weary of uncertainty and therefore are unwilling to plan ahead and spend when they see a retrenching consumer.



Another reason the stimulus (or additional stimulus) will not work is that the deleveraging phenomena is not confined to the U.S. As I have mentioned in previous blogs the two other main economic zones are either suffering through their deleveraging or are so dependent on the other two for their growth.


I know the effort is well intentioned but it simply cannot work in the face of all the headwinds domestically as well as internationally. So why throw good money after bad. You simply can't stimulate an over leveraged consumer by throwing more borrowed money at him. The consumer knows it will take him years before he feels the need and want to consume more. The same goes for businesses, and that is why this recession is not your garden variety one and traditional tools are ineffective.


The amount of debt the government is piling on is going to be a factor in delaying the recovery and making America's product less competitive in world market. This is not your father's America anymore and therefore what may (emphasis on "may") have worked back then will not work today. Back then America was an island with a huge domestic market whose products were pretty much unchallenged. Today the world does not need America's products, actually Americans don't need America's products. Back then America was exporting capital. Today America not only has to compete for money to fund its deficit it actually has to plead for it. In other words America finds itself in most need of liquidity to finance its overextended way of life at a most unfortunate time that the rest of the world is demanding, and in some cases actually supplying, more and more of that limited pie of financial resources.


All is not lost quite yet. But the sooner we acknowledge our deficiencies the sooner we can be ahead of the world in capturing a larger portion of that pie. But this cannot happen until we bring down our standard of living. This can either be planned and carefully thought out resulting in minimum shock or it can be forced on us with dire consequences, but it sure cannot included the paralysing effect of more debt.


What we have is not stimulus. Rather it is a transfer payment. In short, shifting money around creating the illusion of a stimulus.

If I sound a pessimist it is because I am a realist. We should be politically strong enough to tell the nation what needs to be done and not offer politically acceptable solutions that only kick the day of reckoning down the road.


You can email the author at gnasr59@yahoo.com