In with the new…
By Daniel M. Ryan
One of the questions that will hover over President Obama's coming term is whether the McCain/Palin ticket was better off losing in '08. While the Obama administration is discovering that jetsaming the Left is quite compatible with garnering a hugely favorable approval rating, all of us are discovering that stimulus programs aren't quite what they're cracked up to be.
In a way, it's a boon: bailout hopes followed by later bailout disappointments act as a deterrent to demands for even more gargantuous efforts from the government. One of the reasons behind the "Lost Decade" in Japan was early (fiscal) stimulus efforts turning into flotsam.
Of course, the American economy is not like the Japanese one; I assume so too. In fact, my earlier call for a new (if runty) bull market depended upon the assumption that the American economy of today is much like the American economy in the past. Anyone who agrees with this framework would have to conclude that the current stimulus efforts will result in a relatively quick, if relatively weak, economic recovery.
There are actually glimmers of hope in the latest Michigan consumer sentiment survey, and in the commodities markets. The CRB index isn't dropping anymore. Nor is the traditional thumbnail commodity used as proxy for economic forecasting: copper, long known as "Dr. Copper" in the commodity pits. Despite last week's horrendous banking news, the overall stock market hasn't reprised its November plunge to new multi-year lows. These market thumb-rules don't formally comprise a set of leading indicators, but they have been reliable in the past.
Another glimmer of hope is appearing in the relative-prices series that make up the Producer Price Index, although it would take a Hayekian framework to see it. (Paul Samuelson's accelerator effect can serve too.)The Hayekian model, to present it briefly, sees the economy as a structure of production with different stages classified by their distance from the final consumer. The business cycle derived from it looks at relative price movements in each stage of production. According to the Hayekian approach, each stage of production is more volatile the farther it's removed from final consumption. What would be a slight drop in the consumer-goods sector would accompany a severe drop in the raw-goods and commodities sectors. Conversely, what would be a relatively mild boom in consumer-goods industries would be a roaring boom in the sectors most removed. This approach explains the paradox of "deflation" in commodity and asset markets coexisting with still-rising prices in the shops.
As of December, the complete (if not the core) CPI fell – but at a lesser rate than in November. The same deceleration took place with the finished-goods PPI: a 1.9% drop in December as compared with November's 2.2% drop and October's 2.8%. The drop in the intermediate-goods price series was also slightly less in December than November, although the one for core intermediate goods was worse in December than in November. The drop in crude-goods prices was much smaller in December than in November, and November's was less severe than October's. For core crude goods, November's drop was worse that October's but December's was much less than either's. The drop rates in both industrial commodities and all commodities were most severe in October too. Although the figures for November and December are preliminaries, the overall picture suggests a bottoming process that started in November but has yet to fully bottom as of now. So do the sketchier market indicators mentioned in the above paragraph, if anticipation is worked in. [All data contained in this paragraph can be found here.]
A future historian surveying this period might very well categorize the size of the bailouts as a huge price paid for introducing the mark-to-market rule for financial institutions. Since the adjustment to mark-to-market has involved breaking old habits and comfort zones that we didn't even know were there, it's not too shocking that the first post-mark-to-market crisis would have caused the economic tumult that it has. Too many bankers have their habits grounded in the old book-value days, when it was much safer to make deals on assumptions derailed. To be honest, the book-value approach made for a security blanket that was much more comprehensive than it seemed.
Now that the blanket has been taken away, other assumptions are being called into greater question…such as the efficacy of rescue and stimulus packages period. Undeniably, they bring short-term relief: we saw that last spring with the stimulus package signed into law by George W. Bush. The later rescue efforts, though, have multiplied the funds committed without much further relief gained. The point of diminishing returns has not been reached yet, but that point is in sight. It's too early in "Bailout Nation" to peg the current rescue/stimulus packages as "The Bailout to End All Bailouts," but it's close enough to start up a betting pool. The government-bond market has actually helped bail out the U.S. government itself by making the coming huge deficits much less onerous to finance.
Call me cynical, but it looks to me like the U.S. Treasury has been really lucky this time. Luck ran out for the government of Canada as of 1990, when short rates – including T-bill rates - shot up to double digits in a relatively low-inflation environment. The indirect consequence of that awful year was the incongruous sight of Liberal governments running surpluses from about 1997 to the year the Conservatives took over.
Should "Bailout Nation 2" prove to be a real wrecker, there are lost of economists – such as this fellow – who will be glad to explain that Keynes' liquidity trap was nothing more than the result of government's right hand playing tug-of-war with its left hand.
At that point, the end of the bailout road will be reached. Other options will have to be considered…ones like tying the level of deposit insurance per account to followed-through and overseen commitments to: keep leverage levels well below statutory maximums; match deposit/borrowings maturities to loan maturities; cover demand deposits over and above statutory minimums. After all, the moral hazard inherent in deposit insurance would be lessened if prudent banks were rewarded with a sticker displaying a far greater amount than their less prudent competitors are entitled to show.