Friday, March 01, 2013
When Stimulus Doesn't Stimulate
Since 2009, the U.S. has run an average annual deficit of $1.2 trillion. At the same time, the Federal Reserve has expanded its balance sheet by more than $3 trillion. Yet, the economy has only managed to grow at a subpar rate during that period.
Historically, from 1948 until 2012, the annual GDP growth rate in the U.S. averaged 3.22 percent. However, GDP growth has slowed considerably in the last decade. In fact, the average growth rate has been below 2 percent over the last ten years.
The Fed has even held short term rates at a remarkably low level of between 0% and 0.25% since December 2008 and made the unprecedented promise to keep them that low “at least through late 2014.”
What have we got to show for all of these historic interventions? Not much. The economy continues to limp along like a wounded animal. Though you can't prove a negative, perhaps all of these monumental actions averted a full blown depression.
However, the headwinds acting against the U.S. economy have been gathering strength for many years and our share of the global economy has been continually shrinking.
According to the World Bank, U.S. GDP accounted for 31.8 percent of all global economic activity in 2001. That number dropped to 21.6 percent in 2011. That's not just a decline — it's a freefall.
Despite all of the Fed's extraordinary efforts with monetary policy, and despite Congress' aggressive deficit spending, the U.S. economy still surrendered a huge share of global GDP over the past decade.
It's rather amazing that our economic system has held together so well, particularly over the past five years, in the face of all this thin-air money printing and repeated trillion-dollar deficits.
However, these actions are merely acting like duct tape keeping things together. Money-printing and massive deficit spending only offer a temporary respite; they are not long term solutions. They will just create greater long term crises.
Moreover, by forcing near-zero interest rates upon us, the Fed has forced millions of Americans — including retirees — to make big gambles with their life savings. Low rates have driven many people to buy risky assets in the quest for returns high enough to beat inflation.
After lowering short-term rates to near-zero levels, the Fed has lost one of its primary tools for monetary policy. All it has left is its ability to increase the quantity of money.
At present, the Federal Reserve's quantitative easing program (QE) is the lifeblood of the U.S. economy. Yet, despite all of this unbridled money-printing, the economy still contracted in the fourth quarter. Without QE, the economy would seize up. The Fed's funny money — trillions of dollars created out of thin air — is the only lubricant greasing the wheels this economy right now.
The central bank has been purchasing $85 billion in Treasurys and mortgage bonds each month, and says that it will continue doing so for an indefinite period.
Though the Fed has already expanded its balance sheet by nearly $3 trillion buying Treasurys and mortgage bonds (in an effort to lower long-term interest rates and stimulate the economy), this additional $85 billion per month in bond purchases will result in another trillion-plus dollars of freshly created money flowing into the financial system and equities markets over the course of 2013.
The Fed isn't worried, at this moment, about the trillions of dollars is has been printing because the U.S. economy remains gripped by sluggish growth. Many observers predict that the economy will continue to grow at lackluster 2%, or so. Slow growth usually equals low inflation, which keeps interest rates low.
However, as history shows, all of this unbridled monetary easing eventually leads to a sharp increase in inflation and bond yields. It's just a matter of time.
The Fed is conducting a rather dramatic and desperate experiment right now, hoping it won't backfire and unleash a punishing wave of inflation on the American people. Yet, this unprecedented experiment is already having side effects. Though inflation averaged "just" 2.1% in 2012, which many economists consider mild, at that rate the dollar would lose 21% of its buying power by the end of the decade.
The Fed continues to create oodles of money out of thin air, backed by nothing, without regard to the amount of goods and services in the economy. As history shows, this sort of money/currency inflation ultimately leads to price inflation.
The U.S. monetary base (the supply of money) nearly doubled between 1994 and 2006. But then things got really crazy. It doubled twice more, increasing by an additional 221%, from 2006 to 2011. That can only be described as stunning.
None of this even takes into account the amount of debt the federal government has been incurring as it tries to stimulate demand and fill the void created by a hobbled private sector. The national debt now exceeds $16.6 trillion and will surpass $17 trillion before the year is over.
According to the Bureau of Economic Analysis, U.S. gross domestic product totaled $15.8 trillion in 2012, meaning that our debt is now 105% of our GDP.
The 'Debt Held by the Public', which is all federal debt held by individuals, corporations, state or local governments, foreign governments and other entities outside the United States Government, equals $11.7 trillion at present. That amounts to 74 percent of GDP.
In their book, "This Time It's Different: Eight Centuries of Financial Folly," Carmen Reinhart, a University of Maryland economist, and Harvard professor Kenneth Rogoff find that a 90% ratio of government debt to GDP is a tipping point in economic growth. Beyond that, developed economies have growth rates two percentage points lower, on average, than economies that have not yet crossed the line.
For 800 years "you increase it over and beyond a high threshold, and boom!" write Reinhart and Rogoff.
As their work shows, debt ratios that high cause GDP growth rates to fall. That creates a downward spiral. Slowing growth — or worse, a shrinking economy — only causes debt ratios to increase even further.
Unfortunately, the U.S. has now reached that point of no return.
"Highly leveraged economies, particularly those in which continual rollover of short-term debt is sustained only by confidence in relatively illiquid underlying assets, seldom survive forever, particularly if leverage continues to grow unchecked," write Reinhart and Rogoff.
"Sovereign powers saddled with debt loads as large as those of the U.S., Europe, and Japan today are jeopardizing their long-term economic wellbeing."
Since the 2008 financial crash and subsequent Great Recession, the U.S. has added more than $4 trillion in new debt and the Federal Reserve has blown out its balance sheet by more than $3 trillion. Despite these historic and dramatic interventions, the U.S. economy has just muddled along and barely grown.
After contracting in 2009, the U.S. economy expanded 2.8% in 2010, 1.7% in 2011 and 2.2% in 2012. The Congressional Budget Office projects GDP to increase 1.4% this year.
Those weak results are not what one would expect, given all that has been done to bring the economy back to life.
Perhaps the U.S. would still be in the midst of the second Great Depression if not for the massive deficits and money-printing that have ensued. But after all of this spending by Congress, and these stunning monetary interventions by the Fed, it's reasonable to ask:
Is this as good as it gets?