Tax Analysts Blog

Forget the Second Stimulus, Get Ready for the Second Bailout

Posted on Oct 23, 2009

You have cause to be worried. The Dow is rallying but nobody is feeling good. And we're not just talking about the pain felt by the nation's 15.1 million unemployed and the anxiety of all those who fear they might be next.

Two articles in this morning's papers should make even elite capitalist investors worry. "The United States is headed toward a new financial crisis," writes Carnegie-Mellon economist Allan Meltzer in the Wall Street Journal. Based on his extensive historical research Meltzer worries that all the ingredients for disaster are in place: easy monetary policy, unsustainable budget deficits, and a currency expected to depreciate. Part of the solution, according to Meltzer, is immediate action on the long-term deficit: "We do need a fully specified, multi-year program to restore fiscal probity by reducing spending, and a budget rule that limits the size and frequency of deficits. The plan should be announced in a rousing speech by the president.."

Financial Times ace journalist Gillian Tett also is nervous. She has deep sense of foreboding about the current market rally. "This feels horribly familiar," writes Tett. Having written probably the best book out there about the financial meltdown, she should know. According to Tett, the rally is not based on fundamentals (like expected future profits) but on cheap finance provided by the U.S. government: "the longer the money remains ultra cheap , the more traders will have incentive to gamble (particularly if they privately suspect that today's boom will be short lived and want to score big over the next year)." And on top of that "much of the current economic rebound seems to reflect stimulus packages . . . that will end next year."

And on top of all that, the tremendous support governments have provided to financial institutions too big to fail has only weakened their foundations (like too much water weakens the root system of plants). In an October 20 speech, Bank of England governor Mervyn King warned: "The massive support extended to the banking sector around the world, while necessary to avert economic disaster, has created possibly the biggest moral hazard in history. The "too important to fail" problem is too important to ignore."

Now here is the really depressing part. Our leaders are obsessing with politics rather than addressing real economic concerns. Over the objections of the economic team, political spinmeisters in the White House are pushing palliatives like a jobs tax credit and $250 checks to seniors. In Congress, members keep reminding us how extremely busy they are but unfortunately most of their efforts are unproductive. Gimmicks and double-talk may help them get through their legislative days but are not really helping the economy.

First, about the gimmicks. As conservatives love reminding us, President Obama promised health care reform would not increase the deficit by one single dime. But in the first significant piece of health care legislation to hit the Senate floor this year Democrats tried to put the costs of increasing Medicare reimbursements to physicians into a separate bill -- in order to be able to gain the costly ($247 billion) support of the AMA while still technically being able to claim "the" health care bill is deficit neutral. Luckily, the proposal did not pass.

Lest we seem unpatriotic, we hasten to point out budget-squeezed politicians in the United States are not the only culprits in the growing spree of gimmicky public budgeting. In Germany, Chancellor Angela Merkel and her newly-elected conservative coalition are tying to cut taxes without increasing deficit. Their proposed solution to the problem was to put some social welfare programs off-budget and increase the deficit of the off-budget fund. Luckily, it looks like that proposal will be shot down on constitutional grounds. (By the way, Germany recently enacted a constitutional amendment requiring its budget deficit to remain below 0.35 percent of GDP by 2016. Perhaps something the U.S. should think about.)

Now, about the double-talk. The Democrats are desperate to demonstrate their commitment to reducing unemployment (now at 9.8 percent, projected to increase to 10.1 percent in the spring of 2010). But they also face a revolt from moderate "blue dog" Democrats who insist on keeping the deficit in check. So liberals in the United States face the same problem as conservatives in Germany -- how (to appear) to provide stimulus while (appearing to) control the deficit. The approach being explored by U.S. liberals is little bite-sized stimulus measures that only marginally increase the deficit or don't increase it at all. The only problem with this approach is that stimulus that doesn't increase deficits is stimulus in name only. (As any first year Econ student will tell you, increasing the deficit is the essence of Keynesian stimulus.) The logical conundrum of promoting not-deficit-increasing stimulus leads to rhetorical nonsense, outrageous even by Washington standards. Speaker of the House Nancy Pelosi told reporters on October 21: "we do not have plans for an additional stimulus package." Next sentence: "We do have plans to stimulate the economy."

David Broder tells us in today's Washington Post that Obama will get tought on the deficit in next year's State of the Union Address and in his Fiscal Year 2011 budget to be released in February. That's four months from now. In the meantime expect a lot more useless gibberish about non-stimulus stimulus.

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