In 1933, at the height of the Great Depression, John Maynard Keynes wrote in an open letter to President Roosevelt, "The object is to start the ball rolling. The United States is ready to roll towards prosperity, if a good hard shove can be given." President Roosevelt agreed, and in the ensuing years tripled government spending on the myriad programs of the New Deal in an effort to counter the worst economic calamity this country had witnessed in her history.
Fast-forward to 2009, in the aftermath of the market crisis of 2008, and the scene is eerily familiar. The White House, the Treasury Department, Congress and the Federal Reserve have engaged in a massive program of stimulus, a veritable alphabet soup of relief from the Troubled Asset Relief Program (TARP) to the American Reinvestment and Recovery Act (ARARA) to the Term Asset-Backed Securities Loan Facility (TALF). These programs, in addition to a zero interest rate policy, have got the so-called Keynesian ball rolling now, as evidenced by dramatic increases in most major equity market indices, improvements in key housing metrics, a notable upturn in manufacturing and service sector activity, and a more confident consumer.
Nevertheless, recovery still seems nascent, especially among consumers. Retail sales outside of the infamous "cash-for-clunkers" scheme have been tepid at best, with consumers' focus still squarely centered on the weak state of the labor markets and negative home equity values. While actual job losses have abated in recent months, the jobless problem is not to be understated-when "discouraged" and underemployed workers are worked into the calculation, they help yield an unemployment rate of 17.2%.
Corporations are in better shape, but have achieved profitability only through massive cost-cutting measures rather than top-line growth. Meanwhile, according to the Fed's Senior Loan Officer Opinion Survey, business and personal lending has increased only modestly, and lending standards remain restrictive, as banks react to escalating losses and increased delinquencies on consumer, business and real estate loans.
Although the U.S. economy posted 2.9% GDP growth in the third quarter and is on pace to post similar gains in the fourth quarter of 2009 and the first quarter of 2010, the stimulus programs have been working hard to achieve those results. Indeed, without these programs, analysts estimate that U.S. GDP would have contracted at a rate of more than 6% in the second quarter, rather than shrinking only by 0.9%, and the 2.9% growth rate of the third quarter would have instead been a 1% contraction.
Given the challenges-the U.S. consumer is still deleveraging and the banking system is weakened-the U.S. economy could likely falter without the support of the stimulus, leaving many to question the shape and strength of this so-called recovery. A hoped-for "V"-shaped scenario could easily be distorted into a very slow rebounding "U" shape or even a double-dip "W"-shaped recovery with one false move.
President Roosevelt faced a similar turn of events, and many would argue he made a critical mistake in late 1935 and early 1936; when it seemed the economy was recovering, he systematically slashed government spending in an effort to balance the budget. These cuts, in combination with some protectionist, anti-business measures and restrictive monetary policy, were enough to pull the economy back down into a recessionary quagmire. Indeed, many would argue that it was only the mobilization of the nation's resources to fight World War II that ultimately ended the Great Depression.
Drawing on that historical example, recent efforts to withdraw the stimulus have been met with sharp public outcry, and policymakers have ultimately succumbed to demands for more of it even as concerns about the size of the federal deficit grow. Consider the most recent push to not only extend but expand the homebuyer tax credit originally set to expire on November 30, 2009. Meanwhile, the Treasury Department recently announced that it would begin taking action against lenders that are not doing enough to ease mortgage payments for troubled home owners, despite the questionable results achieved on those loan modifications and the improved state of the housing markets. And on the heels of its much-ballyhooed "cash-for-clunkers" program for cars, the federal government is expected to finalize details of another tax-supported shopping extravaganza, known as "cash-for-appliances," that will offer rebates to consumers who buy energy-efficient refrigerators, dishwashers, air conditioners and other appliances to replace their older models.
The Fed is likewise under pressure to maintain a position of low interest rates in its monetary policy "for an extended period," and there is already much discussion about what would happen if it ended its quantitative easing program in March. Some argue the Fed should consider extending that program if necessary and avoid a subsequent spike in interest rates that could derail the stabilization of the housing markets, which are relying on low mortgage rates. To borrow a cliché, it would seem the U.S. economy is standing like a deck of cards, and one wrong pull could send the whole thing toppling over.
Many believe President Obama and Fed Chairman Ben Bernanke, himself a student of the Great Depression, want to avoid a double-dip or prolonged recession, and will instead take the risk of letting the stimulus measures run too far, too long. But survival can only trump fiscal prudence for so long. However, the more we want to avoid a prolonged deflationary period or return to a recession, the more we run the risk of spiraling budget deficits and out-of-control inflation. We also risk shattering the dollar's credibility as the global monetary standard.
While it is difficult to project the future size of the U.S. government's outstanding debt obligations, even the most conservative analysts believe that outstanding public debt, as a share of GDP, will double in the next five years, approaching or exceeding 100% of GDP. If so, the U.S. would be one of the largest debtors (relative to GDP) in the world, and find itself in the illustrious company of Zimbabwe, Jamaica, Italy, Japan and Lebanon. Our "AAA" credit rating would certainly be on the chopping block, which would in turn raise our annual interest expense. When we factor in unfunded Social Security and Medicare liabilities, which dwarf outstanding public debt by well more than eight times, it becomes clear that the federal government will be digging too deep a hole, even if the maximum marginal income tax rate reaches 60%, as some predict it will.