by Dick Morris
Date: Oct 26, 2010
One Month: 0.14
Ten Year: 2.67
Source: U.S. Treasury29
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The idea, of course, was that if interest rates are kept very, very low, businesses will borrow money and use the cash to expand and create jobs. The demand side of the economy was being watered by massive government spending, while the supply side was fueled by low interest rates to encourage business growth.
But it didn’t work. Even with interest rates rivaling Elton John’s famous song “Too Low for Zero,” businesses didn’t borrow, didn’t invest, and didn’t expand.
So the Fed resorted to a novel strategy for flooding the economy with money—“quantitative easing,” a euphemism for printing money.
Of course the Fed didn’t literally operate a printing press. It would have taken too long to churn out enough hundred-dollar bills. Rather, the Fed went to America’s banks and inquired gently if they were interested in selling their mortgage-backed securities.
Were they ever! These bankers had been glumly contemplating their piles of mortgage-backed securities, purchased from Fannie Mae and Freddie Mac at the height of the real estate boom. Once coveted investments, now they were worth nothing. Most were underwater (the debt was more than the land and buildings were worth) and no payments were coming in. Who wouldn’t want to sell these worthless pieces of paper, this confetti?
When the Fed offered to buy them at 100 cents on the dollar, it was as if Santa Claus had just walked in the door.
Banks flocked to the Fed, eager to unload their mortgage-backed securities and the Fed obliged, buying $1.065 trillion of them, pumping huge amounts of cash into America’s banks. In addition, the Fed bought up $832 billion of U.S. Treasury notes and $151 billion of debt issued by other federal agencies. In all, the Fed’s shopping spree injected about $2 trillion into the economy.30
The money supply more than doubled from $853 billion in October 2008 to $2 trillion in October 2010.31
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GROWTH IN MONEY SUPPLY*
(in US$ billions)
07/01/07: $853
08/01/08: $872
10/01/08: $1,136
10/21/10: $1,969
Source: Federal Reserve Board
* * *
The Fed eased up on its purchase of bonds and securities in March 2010, but it is back at it again. Fearful that the economy is in a permanent state of torpor, the Fed is now ratcheting up its purchase of bonds and notes to pump more money into the economy—to do more of what has not worked to date.
Now we are saddled with a vastly expanded money supply, which is growing every day. At the moment, the money is in hiding, awaiting a better economic climate. Consumers, businesses, and banks are all sitting on it and waiting for times to improve.
But one day they will improve and all that money will come out of hiding. All at once. Too much money will be chasing too few goods and services and the result will be awful, untamable, runaway inflation. The classical formulation of the Fed’s role is to dampen the economy once it is moving up. In the words of William McChesney Martin, “to take away the punch bowl just as the party gets going.”32
But now taking away the punch bowl won’t do anything. Everybody has their own private flask of liquid stimulant in their pocket! We all have paid down our credit cards and other debt, businesses are awash in cash, and banks have huge reserves.
The Fed speaks bravely about soaking up the extra money before it can be spent, but has no real plan for doing so.
And why did we accumulate all that debt? What was the big spending for? Why did we print so much money? None of it worked.
BUT IT DIDN’T WORK
So the Keynesian model was fully implemented, beyond anyone’s wildest dreams. And it didn’t work. Nada. Zero. Nothing.
The Keynesian defibrillator sent forth its charge, but the nation’s economic heart didn’t respond. Maybe a beat or two, not much more. The cash for clunkers program triggered a few car purchases. The home buyer tax credit led to some sales. But as soon as the stimulus stopped, so did the buying.
Consumers wouldn’t spend. Businesses wouldn’t expand. Banks wouldn’t lend. The Keynesian stimulus did no good.
Why didn’t it work? Because you can lead a horse to water, but you can’t make it drink!
Obama can pump all the money he wants into the economy, but he can’t make us spend it. And we didn’t.
Look at the data. People didn’t buy cars or appliances or other consumer products. They just pocketed the money.
According to the U.S. Department of Labor, consumers decreased their average spending from 2007 to 2009 by 1.15% per year.33 Almost all categories of products and services suffered cuts in consumer spending.
* * *
CUTS IN CONSUMER SPENDING, 2007–09
(average annual reduction)
Food at home: –8.3%
Food away from home: –1.8%
Housing: –0.2%
Alcoholic beverages: –4.8%
Apparel and services: –8.3%
Entertainment: –0.2%
Source: U.S. Department of Labor34
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The only increases in consumer spending were in health insurance (up 15.5% per year) and education (up 13% per year).35 Of course, health insurance spending is largely involuntary—and stoked by the prospect of the new insurance regulations under ObamaCare—and education spending is vital for workers looking to move out of unemployment.
Instead of using the money to buy goods and services, we used it to pay down credit card debts, reduce our student loans, pay off car loans, and put money in the bank. Meanwhile, we didn’t spend it on anything that would stimulate the economy or create new jobs. The savings rate rose from 3.2% in 2007 to 8% in 2010.36 People sat on their wallets. Sales were flat even as the stimulus money flowed out of the Treasury.
Since the middle of 2008, Americans have cut their total debt by almost $200 billion—an average of $2,700 for a family of four. In August 2010 alone, Americans reduced their credit card debt by $5 billion and their car loans by almost $2 billion.37 Good for them, but not much use for the economy.
Companies didn’t spend their money either. At the end of March 2010, the Wall Street Journal reported that “nonfinancial companies” had socked away $1.84 trillion in cash and other liquid assets as of the end of March, up 26% from a year earlier and the largest-ever increase in records going back to 1952. Cash made up about 7% of all company assets, including factories and financial investments, the highest level since 1963.38
So American companies are sitting on almost $2 trillion of cash—money that could be invested in new factories, a larger sales force, technological improvements, new product lines, or services for consumers. Instead, the companies would rather just sit on the cash and not invest it. No jobs created there.
And the companies, of course, pay a steep price for keeping their cash liquid. They have to be content with the small earnings an almost 0% interest rate can provide. Or they can play the stock market. Or visit Vegas.
Why didn’t consumers spend? Why did business sit on its money? Why didn’t the horse drink the water? Why didn’t Keynesian economics work?
Because consumers and the people who run businesses are not automatons and aren’t crazy. They knew that the checks that flowed from Washington were not going to last forever. They realized that good times were still a long way away.
People are not stupid. They can tell the difference between standing under a shower and standing in the rain. In both cases, you feel water pouring on your head, but one will end as soon as you—or the government—turns off the water, and the other will go on for a while.
The Wall Street Journal phrased it more elegantly: “Consumers are unsettled by the dismal job market and the need to repair household balance sheets badly damaged by the housing bust and the recession.”39
And if consumers aren’t spending, business won’t either. Deutsche Bank
economist Torsten Slok noted that “the problem…is that even though they [American companies] have the wherewithal to bring on new workers, they are holding off until they see more willingness of consumers to spend.” Slok calls it “a vicious cycle of everyone sitting around doing nothing.”40
It should not have come as a surprise that everybody sat on their money. We warned in our book Catastrophe that this is exactly what would happen:
“If taxpayers get refunds and workers get paychecks, why won’t they spend the money? Because people have brains. They’re not animals who respond automatically to stimulation; they know what’s going on. They know the tax refund checks they get are one-shot gifts that won’t come around again. Their anxiety over the future paralyzes their ability to respond to the economic stimulus of the moment the way the economists had hoped.”41
Massive stimulus spending didn’t work in Japan in the 1990s. The ratio of government debt to GDP rose by 217% as politicians spent $1 trillion (double it to find the U.S. equivalent) in a fruitless effort to stimulate the economy. Economic growth averaged 0.6% a year during this period.42
It didn’t work when President George W. Bush sent out rebates to every American household in 2008. He sent out $100 billion in checks, a pittance compared to Obama, but only 10–20% of the money was actually spent on goods and services.43 They saved the rest or used them to pay down bills and loans.
And why didn’t the banks lend out the money the Federal Reserve Board was sending their way? The banks sat on the money because of their worries about the economy, but also because they had something much better to do with their newfound wealth: lend it back to the government!
Why should banks take risks on new mortgages, car loans, business development, commercial real estate, manufacturing expansion, or entrepreneurial initiatives when the government is ready to borrow all the money they can lend?
Remember that banks got their capital, essentially, for free by selling the Fed their worthless mortgage-backed securities or by borrowing from the Fed at interest rates close to zero. Banks incurred no cost in acquiring their capital. These bankers instead lent their new cash back to the federal government from whence it had come at an interest rate averaging 3.5%. This spread between the cost of acquiring capital and the earnings it generates is enough for any banker. No stockholder could expect more.
And, of course, the government loans are risk-free. By definition, they are guaranteed by the full faith and credit of the United States government. You can’t get any safer than that. No matter how overextended our exchequer becomes, the power to tax the largest economy—by far—in the world lies behind the debt, securing its repayment.
So why should bankers fool with lending money to a pair of young geniuses who are nursing the next big idea in their garage? So what if it might sprout into the next Microsoft or Dell if they could get capital? Better to be content with an adequate return on your loans with a government guarantee. Nothing is safer or more certain to make you money. After all, getting capital for free and lending it out at 3.5% makes it impossible not to make money and bankers know it.
So banks wouldn’t lend to the private sector, consumers didn’t buy new goods or services, and companies refused to part with their cash or make investments in expansion.
Obama’s principal strategy for solving the recession didn’t work. When he took office, unemployment was 7.7%. By November 2010, it was 9.8%, with not much prospect of going down.44 And even these stats understated the problem. When you add the underemployed who work part-time for economic reasons and “marginally discouraged workers” (folks interested in working who have looked for a job in the past year, but are not now actively searching for jobs) the rate grows to 17.1%.45
The rest of the world has been recovering. But not the United States. We are getting over the recession much more slowly than any other industrialized country.
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U.S. GROWTH RATE COMPARED
(Second quarter, 2010)
Country: U.S.
Average Annual Growth: 1.7%
Country: Euro Zone
Average Annual Growth: 4.0%
Country: United Kingdom
Average Annual Growth: 4.8%46
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What’s the difference? We have Barack Obama as our president and they don’t!
OBAMA’S REAL AGENDA
Why was Obama so wrong? Why did he bet so heavily on an economic theory that had been so discredited? Was he stupid? Crazy?
He was crazy like a fox! Barack Obama is not stupid. He could not really have imagined that his massive stimulus borrowing and spending would grow the economy.
The truth is that he didn’t care. His goal was not recovery. Not improving America. Not making things better. Not stimulating private sector growth.
He wanted to use the recession to expand the public sector. As Rahm Emanuel, his first chief of staff, famously said early in Obama’s presidency, “You never want a serious crisis to go to waste.”47
The new spending was not a means to the end of recovery. The additional outlays were themselves the goal. Barack Obama wanted to expand the public sector to make us into a government-centric economy. He wanted to diminish the private sector and expand the role of government. In short, he wanted to raise the level of public spending in the United States to more nearly approximate that of Western Europe with its socialist democracies.
The goal of increasing public sector spending has long been deeply embedded in liberal ideology. John Kenneth Galbraith, the leading economist of the left, pled constantly in his books during the 1960s and ’70s for an expansion in government spending and investment in the public sector.
American liberals looked with jealousy at the vast public sectors of Western Europe and were determined to pick up the pace of U.S. government outlays.
Obama simply took an eight-year wish list of spending projects and passed it all in one week. His hope was not that the spending would encourage the private sector. He wished the exact opposite—he wanted government spending to replace the private sector.
Obama, of course, realized that a higher deficit would make the pressure for higher taxes inevitable. And that was also his goal. He wants a tax policy that takes from the rich and gives to the poor—a Robin Hood increase.
Obama’s campaign promise that he would not raise taxes on the middle class does not give us much comfort. We don’t believe him in the first place. And even if we did, we have all come to realize that a tax hike on some of us impacts us all.
The recession has changed American opinions about tax policy. In 2008, voters did not mind taxes rising on the rich as long as they were not personally affected. But the recession has shown us all that any tax on anyone depresses the economy and saps economic growth.
We are finding out that while class warfare makes great politics, it is lousy economics. According to new research from Moody’s Analytics, the top 5% of Americans by income account for 37% of all consumer outlays. Outlays include consumer spending, interest payments on installment debt, and transfer payments.48 And consumer spending generates 70% of our Gross Domestic Product.49
A Rasmussen Reports poll on September 13, 2010, found that, by 51–44%, U.S. voters wanted to extend the Bush tax cuts—including those for rich people. (This poll was conducted before Obama conceded the point.) Offered a choice between extending the tax cuts for all Americans and extending them for everyone but the wealthy, 48% opted to extend them for everybody, and just 41% wanted them for all but the rich.50 A majority of our countrymen now realize that even if they don’t personally pay more in taxes, they will end up paying by losing their jobs.
Obama has abandoned, for now, his efforts to repeal the Bush tax cuts on those making more than $250,000 a year. But don’t be fooled. He will return to his demands after the extension has expired two years hence, if he is reelected. Only by defeating him can we defeat this tax increase in the future.
By threatening to raise taxes on the big spende
rs, Obama is once again placing his social priorities in the way of our economic needs. He is so anxious to soak the wealthy and redistribute income that he is willing to kill the goose that lays the golden egg.
His goal is to spend and tax us into his vision of a reengineered society. That’s his idea of “social justice.”
But Americans are realizing that the big spending programs he is passing are stopping us from recovering from the recession.
AMERICA BECOMES A DEBT SLAVE
Each new stimulus bill, every additional dollar of deficit and debt, each new federal regulation or tax or fee drains our economic corpus of the very blood it needs to survive and prosper. But Obama keeps draining away the blood, oblivious to its effect on us as he focuses, like Captain Ahab, on his ideological objective of income redistribution.
But Obama’s spending did a lot more than just fail to lead to recovery. It has transformed the United States into a debt slave, perhaps permanently, because every dollar the government spent, it borrowed.
His new spending caused the federal deficit to explode beyond all reason. After decades of deficits that hovered around 3 or 4% of our economy, we now have one that has reached almost 10% of our GDP.51
Obama’s defenders say that the Bush administration racked up a deficit of $1.3 trillion and that the 2009 shortfall of $1.6 trillion is only slightly greater. But this argument is a sleight of hand. The final Bush deficit, in his 2008–09 budget, was supposed to be $458 billion.52 But, because of the recession, it had risen to about $713 billion by the time he left office.53
In September 2008, the banking system collapsed and the administration rushed in with loans to shore it up. The TARP (Troubled Asset Recovery Program) lent out $700 billion to financial institutions to stop them from going under. Because the federal budget makes no distinction between spending and lending, all $700 billion went on the balance sheet, driving the deficit for FY2009, up to $1.4 trillion—of which half was the TARP loans (the $713 billion of real deficit plus the $700 billion of TARP loans.)