November 17, 2009
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Birds are singing, the sun is shining and life is beautiful again. On the surface, the vital signs of our economy are improving with every economic report. In some areas, like unemployment, the rate of decline is decelerating; in others, like GDP, decline is turning into growth. The stock market is behaving as if the history of the last twenty years is about to repeat itself: recession will turn into a robust expansion. Stock prices are discounting an expectation of robust earnings recovery to a level only slightly below the pre-financial crisis level, and risk taking is in vogue again as the performance of junky stocks trumps quality.
The global economy reminds me of a marathon runner who runs too hard and hurts himself. But now he has another race to run. So he’s injected with some serious, industrial-quality steroids, and away he goes. As the steroids kick in, his pace accelerates, as if the injury never happened. He’s up and running, so he must be ok; this is the impression we get, judging from his speed and his progress.
What we don’t see is what is behind this athlete’s terrific performance – the steroids.
Of course, we can keep our fingers crossed and hope that the runner has recovered from his injury and what we see is what we get – the athlete is at the top of his game – but there are problems with this thinking. Serious steroid intake comes at a cost: it exaggerates true performance. Steroids can be addictive; once we get used to their effects it is hard to give them up. The longer we take them the less effective they are. Finally, there is a good reason why steroids are banned in sports: they damage the athlete’s body.
Our economy suffered severe injuries last year, and to keep it going massive amounts of steroids were and are being injected – they’re what economists call stimulus (or government intervention).
Let’s take a closer look at the extent of the steroidization (to coin a new word) of our economy, and its side effects.
I’ll focus on the US economy, but similar arguments to varying degrees are true for many countries around the world. In the US, things appear to be stabilizing and improving on the surface, but beware, there is a giant IV hooked up to the veins of the economy, through which billions of dollars are constantly being pumped in. The stimulus is everywhere:
- To help the auto industry taxpayers were subsidizing the price of autos through the “cash for clunkers” program and thus were creating artificial demand. In addition, GMAC is to receive a third government bailout. So far taxpayers have pumped $13.5 billion into GMAC.
- The housing market, the epicenter of this crisis, is propped up from different directions. On one side there is a buyer (it used to be the just first-time buyer, now it is any buyer) tax credit. From a different direction interest rates are kept low by the Fed’s quantitative easing, fancy econ-speak for the Federal Reserve buying long-term bonds and thus keeping long-term rates artificially low. Finally we have the (now) defunct government-controlled Fannie and Freddie, which are the mortgage market of our economy, since they account for the bulk of mortgages originated today.
- Since banks are the conduits through which the government pumps stimulus into the economy, the aforementioned government involvement in the housing market helps them generate enormous fees. In addition, profitability is boosted (at the expense of savers) by the near zero short-term interest rates, again thanks to the friendly Fed, that allows banks to earn a healthy interest-rate spread.
Last, and certainly not least, the giant, multi-hundred-billion-dollar infrastructure projects are coming on line as you read this. Yes, steroided we are.
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