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Failure of the Economic Stimulus Package
(Reprint July 2009)

The data is in. Here’s what happened:
1. Household personal income (inflation adjusted) rose but every penny - and then some - went into savings or paying down debts. Consumer spending, on which Obama is betting to stimulate the economy, actually fell. None of the stimulus money was sent. None.
2. Meanwhile, to pay for this stimulus spending that didn’t stimulate, Obama had to borrow so much money that long term interest rates have almost doubled since he took office, forcing postponement of abandonment of business expansion and hiring across the board.

What a record!

Here are the details. In April, personal household, inflation-adjusted income rose by $122 billion. Of that increase, one-third or $44 billion came from the government’s stimulus program.

But while personal income was rising, household savings (which includes paying down credit card balances, mortgages, student loans, car loans, etc) rose by $132 billion — $10 billion more than the rise in income. So personal consumption dropped 0.1%.

The stimulus package was a total and complete failure. As predicted, as happened with Bush’s 2008 tax cut, as happened with the Japanese stimulus packages of the 90s, fearful consumers sat on their money and wouldn’t spend it. Keynesian economics didn’t work. Again.

But the debt sure piled up. The deficit quadrupled and is sending interest rates soaring as the government elbows aside businesses and consumers at the loan window, all in a desperate effort to borrow enough money to spend enough money to stimulate the economy which isn’t happening.

Keynesian economics doesn’t work.
Consumers are not idiots.

They know that when their paycheck is fatter - either because of tax cuts or government spending - that it is not the beginning of nirvana but just a short term, one shot respite from hard times. They know the difference between standing in front on an electric fan and a windy day.

Barack Obama has fatally undermined our currency, our solvency, our financial stability, and - ultimately - our economy all to spend money that has had no economic effect!

Is Obama a failure? Not by his lights. His goal was never to stimulate the economy. His goal was to expand government spending and he used the recession as an excuse to do so.

And, by this standard, he is a raging success. With the stimulus spending, the government proportion of GDP will rise from about 35% to about 40% and with health care “reform” it will go soaring into the mid-forties, bringing us to parity with Germany en route to France!

The results are in: None of Obama’s spending
is doing anything to help the economy.

Of course, the process of household savings, designed to pay down debt, is very healthy. Economists call it de-leveraging. By the start of the recession, the debt American households owe had risen from 70% of their annual income in 1995 to 140% (excluding mortgages).

Now it is on its way back down again. And, eventually, that will lead to a real recovery — If Obama doesn’t wreck the currency and bring on mega-inflation before then.

Reference
*Failure of Obamanomics

New money created on the strength of a flood of new debt, is tantamount to pouring gasoline on the fire, making prices fall and the economy contract even more.

The Obama administration has missed its historic opportunity to stop the deflation and depression inherited from the Bush administration because it entrusted the same people with the task of damage-control who had caused the disaster in the first place: the Keynesian and Friedmanite money doctors in the Fed and the Treasury.

Watching the wrong ratio

The key to understanding the problem is the marginal productivity of debt , a concept curiously missing from the vocabulary of mainstream economics. Keynesians take comfort in the fact that total debt as a percentage of total GDP is safely below 100 in the United States while it is 100 and perhaps even more in some other countries.

However, the significant ratio to watch is additional debt to additional GDP , or the amount of GDP contributed by the creation of $1 in new debt. It is this ratio that determines the quality of debt .

Indeed, the higher the ratio, the more successful entrepreneurs are in increasing productivity, which is the only valid justification for going into debt in the first place.

Conversely, a serious fall in that ratio is a danger sign that the quality of debt is deteriorating, and contracting additional debt has no economic justification.

The volume of debt is rising faster than national income, and capital supporting production is eroding fast.

If, as in the worst-case scenario, the ratio falls into negative territory, the message is that the economy is on a collision course and crash in imminent.

Not only does more debt add nothing to the GDP, in fact, it causes economic contraction, including greater unemployment.

The country is eating the seed corn with the result that accumulated capital may be gone before you know it.

Immediate action is absolutely necessary to stop the hemorrhage, or the patient will bleed to death.

Keynesians are watching the wrong ratio, that of debt-to-GDP. No wonder they constantly go astray as they miss one danger signal after another. They are sailing in the dark with the aid of the wrong navigational equipment. They are administering the wrong medicine. Their ambulance is unable to diagnose internal hemorrhage that must be stopped lest the patient be dead upon arrival.

Early warning

In the 1950’s when the dollar was still redeemable in the sense that foreign governments and central banks could convert their short-term dollar balances into gold at the fixed statutory rate of $35 per ounce, the marginal productivity of debt was 3 or higher, meaning that the addition of $1 in new debt caused the GDP to increase by at least $3.

By August, 1971, when Nixon defaulted on the international gold obligations of the United States (following in the footsteps of F.D. Roosevelt who had defaulted on its domestic gold obligations 35 years earlier) the marginal productivity of debt has fallen below the crucial level 1. When marginal productivity fell below $1 but was still positive, it meant that total debt (always ‘net’) was rising faster than GDP.

For example, if the marginal productivity of debt was ½, then $2 in debt had to be incurred in order to increase the nation’s output of goods and services by $1. An increase in total debt by $1 could no longer reproduce its cost in the form of an equivalent increase in the GDP. Debt lost whatever economic justification it may have once had.

The decline in the marginal productivity of debt has continued without interruption thereafter. Nobody took action, in fact, the Keynesian managers of the monetary system and the economy stone-walled this information, keeping the public in the dark.

Nor did Keynesian and Friedmanite economists at the universities pay attention to the danger sign. Cheerleaders kept chanting: “Gimme more credit!”

I learned about the importance of the marginal productivity of debt from the circulated Bulletin of Hungarian-born Chicago economist Melchior Palyi in 1969.

(There were altogether 640 issues of the Bulletin; they are available in the University of Chicago Library). Palyi warned that the tendency of this most important indicator was down and something should be done about it before the debt-behemoth devoured the economy. Palyi died a few years later and did not live to see the devastation that he so astutely predicted.

Others have come to the same conclusion - Peter Warburton in his book Debt and Delusion: Central Bank Follies That Threaten Economic Disaster (see references below) envisages the same outcome, although without the benefit of the concept of the marginal productivity of debt.

The watershed year of 2006

As long debt was constrained by the centripetal force of gold in the system, tenuous though this constraint may have been, deterioration in the quality of debt was relatively slow.

Quality caved in, and quantity took a flight to the stratosphere, when the centripetal force was cut and gold, the only ultimate extinguisher of debt there is, was exiled from the monetary system.

Still, it took 35 years before the capital of society was eroded and consumed through a steadily deteriorating marginal productivity of debt.

The year 2006 was the watershed. Late in that year the marginal productivity of debt dropped to zero and went negative for the first time ever, switching on the red alert sign to warn of an imminent economic catastrophe. Indeed, in February, 2007, the risk of debt default as measured by the skyrocketing cost of CDS (credit default swaps) exploded and, as the saying goes, the rest is history.

Negative marginal productivity

Why is a negative marginal productivity of debt a sign of an imminent economic catastrophe? Because it indicates that any further increase in indebtedness would necessarily cause economic contraction. Capital is gone; further production is no longer supported by the prerequisite quantity and quality of tools and equipment. The economy is literally devouring itself through debt.

The message, namely that unbridled breeding of debt through the serial cutting of the rate of interest to zero was destroying society’s capital, has been ignored. The budding financial crisis was explained away through ad hoc reasoning, such as blaming it on loose credit standards, subprime mortgages, and the like.

Nothing was done to stop the real cause of the disaster, the fast-breeder of debt. On the contrary, debt-breeding was further accelerated through bailouts and stimulus packages.

In view of the fact that the marginal productivity of debt is now negative we can see that the damage-control measures of the Obama administration, which are financed through creating unprecedented amounts of new debt, are counter-productive. Nay, they are the direct cause of further economic contraction of an already prostrate economy, including unemployment.

The head of the European Union and Czech prime minister Mirek Topolanek has publicly characterized president Obama’s plan to spend nearly $2 trillion to push the U.S. economy out of recession as “road to hell”. There is absolutely no reason to castigate Mr. Topolanek for this characterization.

True, it would have been more polite and diplomatic if he had couched his comments in words to the effect that “the Obama plan was made in blissful ignorance of the marginal productivity of debt which was now negative and falling. In consequence more spending on stimulus packages would only stimulate deflation and economic contraction.”

Reference
*Stimulus Package Doomed To Failure

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