State Spending Spree Will Save Us, but at a Price

Lot’s wife looked back at a scene of devastation and was turned into a pillar of salt. Salt – as in the salty tears we shed last week as we looked back on the economic devastation of 2008, truly an annus terribilis, if we might be permitted to trump Her Majesty’s annus horribilis of a few years back.

Most forecasters are expecting an even bleaker 2009 in America. The unemployment rate is expected to hit double digits, output to drop by between 5% and 10%, repossessions of homes to soar, protectionism to stalk the international economy, more and more firms to file for bankruptcy as they find themselves unable to refinance the $1 trillion in loans that Reuters estimates are coming due in the next three years . . . fill in your own predicted horror to round out the list.

These forecasters study their models of past behaviour for a clue to the future. I am not a member of that fraternity, but a mere guesser of what might be in store for us in 2009, especially in a year in which government policies – some new, most of unprecedented magnitude – will drive events.

Disciples of the late, great John Maynard Keynes believe that the deficit spending being undertaken by governments around the world will trigger an economic recovery. On their side are two groups who see the crisis as an opportunity: they would have welcomed such spending even if we were not in recession.

One simply distrusts the market, dislikes the way it distributes incomes, and sees government bailouts of banks, insurance companies, car manufacturers and others as a small price to pay for greater control of the commanding heights of the economy. How delicious it is to control executive bonuses, tell motor companies to produce greener cars whether consumers prefer them or not, and guide the lending policies of banks and other financial institutions.

The other group has long believed that John Kenneth Galbraith had it right when he referred to private opulence and public squalor – underinvestment in infrastructure, overconsumption of baubles, bangles and beads. Now they have their chance. Barack Obama sooner or later will increase taxes on the rich to curb their ability to indulge in jets, yachts and expensive stiletto shoes. That money, supplemented by huge borrowing, is to be redistributed to lower-income groups, and used to build roads, bridges, schools and whatever politicians can cram under the rubric “infrastructure”.

The current recession /credit crunch provides an excuse for these groups to form a coalition with those focused exclusively on getting the economy moving again. Result: Obama will spend a few dollars short of a trillion on infrastructure projects (politicians here still fear a negative reaction to the T-word, so the Obama team is putting a price tag of only $850 billion on its new spending package). The 11,391-item wish list of “shovel-ready” projects presented to the president-elect by the nation’s mayors includes $1.5m to get prostitutes off the streets of Dayton, Ohio; a few hundred thousand to heat a swimming pool in Hawaii (average temperature about 20C); and a trifling $80m for loading docks at the Philadelphia Museum of Art. Better “to dig holes in the ground, paid for out of savings, [which] will increase, not only employment, but the real national dividend of useful goods and services”, as Keynes contended, only partly tongue-in-cheek, or to drop money from helicopters, as Federal Reserve Board chairman Ben Bernanke once proposed, also only partly tongue-in-cheek. Especially if you live where most Americans live – in urban areas. The history of infrastructure spending is that a disproportionate sum goes to rural areas, for nice smooth roads to nowhere, while the cities’ potholes remain large enough to swallow entire vehicles. “Helicopter Ben” might at least overfly cities, giving urbanites a fairer share of the government’s beneficence.

The Treasury and the Fed are running the printing presses overtime. Billions of dollars are being created out of thin air to fund Obama’s stimulus, to buy toxic assets from financial institutions, to bail out car companies and insurers. It is difficult to see how all the money that will be sloshing around the economy will fail to produce some sort of recovery. Bernanke is determined to drive down the cost of mortgages and of corporate and interbank borrowing, and there are signs that he is succeeding.

The federal government is determined to shore up almost any firm that claims to be too big or “too interconnected to fail”, and to rebuild the nation’s infrastructure, broadly defined. Skittish consumers are borrowing and spending less, but government spending will more than make up for this. The wall of money stashed in low-paying Treasury IOUs will sooner or later wash back into shares and corporate bonds. The $500 billion that Bernanke will use to buy up mortgage-backed securities cannot but help to loosen that part of the credit market, just as the bailout of General Motors’ credit arm, GMAC, will make it easier for less credit-worthy consumers to buy cars with no down-payment and no interest charges.

Moves such as that might be recreating the excess credit culture that brought us to this pass, but better that than a prolonged recession – so believe politicians for whom the 2010 elections are just around the corner, and Bernanke, whose claim to academic fame is his study of the causes of the Great Depression.

It will be surprising indeed if all of these moves don’t put the economy on the path to recovery by the end of the year. And on the path to a round of inflation that Larry Summers, tipped to occupy the Fed chairman’s seat, and other Obama advisers feel they can pinch off by quickly draining excess liquidity from the economy by raising interest rates and – you guessed it – taxes. Holders of dollars hope these economist-paragons are not prisoners of their adoring press; otherwise, the dollar will race the pound to the bottom of the currency heap.