Will Obama's Economic Policies Drag the U.S. Down?
Things are turning nasty for the U.S. economy. Just how nasty was made clear when on hearing of Obama's victory the markets fired a salvo across the bows of the Democratic Party. Markets are always forward looking, and what they said was that Obama's ragtag baggage of economic nostrums pose a severe threat to the American economy and hence recovery.
Unfortunately the Democrats seem to think economic laws are some kind of Republican trickery that can be safely ignored once they have the reins of power in their hands. That the slogan "Yes we can!" stirs an emotionally (and therefore unthinking) crowd into such a frenzy of adulation it can only alarm the markets, which is exactly what happened. One need only look at the Dow Jones Industrial Average Index and the S&P 500 Index to get an inkling of how grim the economic landscape now looks.
But like a drowning man reaching out for help when none is even there, the same Democrats and their media pals have discovered that the yield curve has turned positive and is in fact unusually steep. This, they imagine, means that an economic recovery is, if not actually on the horizon, fast approaching it. I wouldn't bet on it. It's pretty difficult to imagine that the same markets that only just condemned Obama's economics are now preparing to underwrite them with an economic recovery.
To get a grasp, no matter how slender, of what is happening, it is necessary to spend a little time on explaining the yield curve. Financial folklore has it that when the yield curve is negative (short term interest rates are higher than long term rates) this indicates an impending economic contraction. The reverse is said to hold when short term rates are lower than long term rates.
Any economist would, or at least should, tell you that a free market always moves to equalise prices for the same good or service. Yet when it comes to short and long term yields the very same economist changes course and struggles to conjure up a variety of reasons as to why this fundamental economic law has been suspended in the case of interest rates. As the noted economist Knut Wicksell first explained in 1898:
[i]t is important to notice that the long-term rate of interest (the bond rate of interest) must correspond somewhat closely to the short-term rate of interest (the bank rate of interest), or at any rate that a certain connection must be maintained between them. It is not possible for the long-term rate to stand much higher than the short-term rate, for otherwise entrepreneurs would run their businesses on bank credits, this is usually feasible, at any rate by indirect means. Similarly it cannot stand lower than the short-term rate, for otherwise most capitalists would prefer to leave their money at the Bank . . . (Knut Wicksell, Interest and Prices, Sentry Press New York, 1936, p. 75)*
One is left to conclude that the "yield curve" is really a creature of monetary manipulation by central banks. By expanding credit the Fed lowers long term rates and stimulates production. When the Fed feels the need to tighten its monetary policy short term rates rise and production contracts. The federal funds rate is now 1 per cent, an extremely low rate. In addition, the monetary base has been jacked up from $980,914 billion on 8 October to $1,233,679 on 5 November, a leap of 24.7 per cent. The chart below shows how swift and steep this increase is.
No wonder the yield curve is positive: but does this mean an economic revival? Not necessarily. Low interest rates are useless if the government's economic policy is hostile to profits and investment. At the moment this certainly appears to be the case with Obama who has in tow a barrage of spending and taxing programs the likes of which the U.S. has not seen since Roosevelt's destructive New Deal, that brilliant economic strategy that prolonged the Great Depression.
Obama intends to savage capital gains, raise other taxes and massively increase government spending. Between this quarter and the first quarter of 2009 the Treasury is expected to borrow more than $920 billion. The way this is going, we will soon be talking trillions. This is no exaggeration. B. Scott Minerd, CEO and chief investment officer of Guggenheim Partners Asset Management, has been reported as estimating total Treasury borrowing for fiscal 2009 will total $1.5 trillion-$2 trillion. This kind of spending during a boom is bad enough but America is in a recession. (Perhaps someone forgot to tell the Democrats that revenue falls during recessions).
Yet the Democrats seem to be blissfully ignorant of the fact that markets are scrutinising them intently. They are not impressed with Obama's witch's brew of higher taxes, greater government spending and more and more regulations. Markets fully understand that there is nothing here that is conducive to economic growth let alone economic recovery. And this brings us right back to the yield curve. Those who think that the yield curve is indicative of an economic revival have missed a vital piece of information. As the curve steepened the cost of insurance against a default by the U.S. Treasury has also risen, and risen sharply.
There exists what is called credit-default swap, a sort of credit derivative that resembles an insurance contract which provides a buyer with protection against given risks. As a rule credit default swaps protect corporate bond investors against default by the issuers of the corporate bonds. Naturally, one expects the cost of this type of insurance to rise with the risk of default. And this is what has been happening with respect to the U.S. government.
The devil, as they say, is in the details. The markets doubt that there are sufficient domestic savings as well as foreign demand to take up Treasury debt. Even if the savings are available this amounts to diverting funds from investment to government spending which can only weaken the economy. In circumstances such as these the temptation to monetise the debt might prove irresistible.
Bernanke's misreading of the 1930s and his apparent eagerness to please Obama might make him highly susceptible to this 'solution'. The lowering of the fed funds rate to 1 per cent and the massive increase of the monetary base most certainly point to this possibility. In short, the market suspects that an Obama regime would willingly implement a highly inflationary policy rather than abandon to any significant degree its proposed interventionist policies.
Some call Obama a Marxist. Be that as it may, to me he's beginning to look more and more like Juan Peron. When faced with the disastrous consequences of his interventionist economic policies Peron's response was to insist on more of the same, just as Roosevelt did. What can I say, other than: Hola! Argentina.
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This article has 15 comments:
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Nikola
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91 Comments
Nov 17 05:04 AMAnd the fact that the market went down after election can be attributed to nothing other than the fact that Obama was elected. Then what has the market been doing for the past 8 years, huh? The stock market voted you people out of office, so quit talking about the market, ok?
Talk about national security or something. Talk about how closing down Guantanamo and not torturing people is a bad idea. Talk about something where we don't have a verdict yet. Oh wait, we already do have a verdict on Republican mismanagement of the War on Terror.
Talk about the weather will you. Oh, that's no good either. (Can you say Katrina?)
You folks (and that's how you liked to be called) should really just go play golf for the next few years. You've got nothing to say.
Shameless, truly shameless.
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Gtarras
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37 Comments
Nov 17 05:30 AMyou wont even share with us your picture or background, and yet you are compelled to go down on policymakers like a ton of bricks? you spent so much time writing this STUFF, and yet nobody will care.. sad...
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Alan von Altendorf
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357 Comments
My Website
Nov 17 06:15 AM-
Tim Miles
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56 Comments
Nov 17 08:34 AM-
youngolf
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25 Comments
Nov 17 08:44 AMWill Obama policies drag the US down? Where do you think we already are at the moment? The majority of us are tired of electing the usual rich white republican or professional politician to head this once great country.
After watching the 60 Minutes interview last night, it looks like Obama and wife are a good pair, down to earth, familiy oriented, and actually may just have an inkling of what it is like as an average citizen outside the exclusive country club set.
And I am a 50yr old white male with a MBA, and a former republican voter!!
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brokerinbirmingham
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16 Comments
Nov 17 09:49 AMAs these other bloggers have said, Democrats can easily tell how you're just using Republic trickery. Rich White Republicans (RWR) just don't want to give a massive tax hike a chance to work. As everyone knows, (Pravda was always fond of using that phrase, which indicated to the reader whatever came after was patently false) central planning worked wonders for the Soviet Union economy. I mean, didn't the huge taxes produce the best of everything for millions of Russians? Once the RWR's and the taxable middle class are brought down (just like we did in 1917, 1930's, Cambodia, etc) everyone will prosper! It's been shown time and again how well this will go down. Huge taxes and central planning has produced the absolute best societies in the world. You RWR don't fool us Democrats. Yield curve be damned! DJIA be damned! S&P500 is a lie! Just open your eyes man. When Mr. Obama is allowed free reign, then you'll see Heaven on Earth (paid for by the U.S. taxpayer of ALL levels, not just the >$250, 200, 150, 100, whatever).
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WayneS
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57 Comments
Nov 17 10:30 AM-
Tom B
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1771 Comments
Nov 17 10:43 AMObama has several advantages over Bush 1) He's smart 2) He favors competant advisors. I don't know what he's planning, but if he can 1) slow/ease foreclosures 2) get money to the middle class 3) fix trade, things will start getting better.
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Jimbo
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142 Comments
Nov 17 11:02 AM-
DougM
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113 Comments
Nov 17 12:20 PM-
still renting
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144 Comments
Nov 17 04:41 PMWell, let's just see if this guy Obama becomes another FDR or a true visionary. I already have my suspicions, based on his campaign promises, but we'll soon see the difference between Obama the Santa Claus and Obama the President. If the two are one in the same, we're in a heap o' trouble.
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zalaywan
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1 Comment
Nov 17 05:32 PMOn Nov 17 10:43 AM Tom B wrote:
> If "W" hadn't 1) blown 10-12 billion/per month in Iraq WITHOUT GETTING
> THE OIL PROFITS 2) kept an eye on subprime before it exploded, we
> wouldn't be in a severe recession now. Maybe we'd have no recession,
> or even growth. We've got troubles until, 1) the overhang of foreclosures
> eases 2) people actually have JOBS again (you know, it's tough to
> grow the economy without actual CONSUMERS.
>
> Obama has several advantages over Bush 1) He's smart 2) He favors
> competant advisors. I don't know what he's planning, but if he can
> 1) slow/ease foreclosures 2) get money to the middle class 3) fix
> trade, things will start getting better.
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lewisabroad
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8 Comments
Nov 17 06:20 PMIf markets are forward thinking (I believe they are mostly driven by irrational behavior), then analysts would have looked at the Iowa Elections Futures market and priced in the winner (Obama) a while ago.
Markets are mainly looking at the unemployment bogeyman and running scared. That factor alone will do more to damage any company's forward looking earnings more than polcy changes like reinstating old tax rules form he '90s or a stimulus package.
This guy is a political hack (and an idiot) - this problem goes way deeper than Rep/Dem conflicts. Everyone in gov't could be blamed, Bush for spending us into a hole, Dems for loosening restrictions on home lending.
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msoori
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71 Comments
My Website
Nov 17 09:20 PMPeople voted the Republicans because they did nothing but screw this country for the past 8 years, under the guise of fighting terrorism. Republicans cut their own grave stealing from the poor and off shoring their jobs. They have sold not only our future, but the future of our children and the children of our children. At least have the decency to give Obama the chance to fix this mess... a chance you have given to the Republicnas not only for 4, but for 8 years of mediocre, self centered "leadership"
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Unrepresented Taxpayer (the oth...
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4 Comments
Nov 17 10:11 PM