Yesterday Fed Chairman Ben Bernanke pulled out the last bullet in his arsenal hoping that just maybe this “silver bullet” will kill the vampiric drain of excess debt on the economy. Unfortunately, silver bullets don’t kill vampires.
There is more to this analogy than just the approaching Halloween season. Our problem isn’t low interest rates – it is excess debt which literally drains the demand for more credit. The recent release of the NFIB Small Business Survey stated that businesses having access to credit is not an issue. “Poor sales” are their number one concern and the lack of demand on their businesses do not warrant adding on more leverage. The number of businesses currently thinking this is a “good time to expand” is at some of the lowest levels on record. Likewise, consumers, are trying to pay down debt as worries about job security, rising food and energy costs and stagnant wages reduce their desire to consume and make debt reduction a priority. The excess debt that has been accumulated over the last 30 years as interest rates were in a steady decline, lending standards were reduced and massive pools of available credit were supplied has now begun the inevitable unwinding process.
Ben wrongfully believes that by lowering interest rates on longer dated maturities it will cut long-term interest rates boosting investment in both housing and business. The reality is that interest rates are already at levels twice as low as they were the last time “Operation Twist” was implemented and if the lowest rates in 50 years aren’t spurring a demand for credit in the economy – it is doubtful that a further decline will do the trick.
During the previous “Operation Twist” the economy was experiencing a increasing trend of growth. Interest rates were also steadily rising as stronger economic growth allowed for higher rates of interest to be charged. Debt, as a function of GDP, remained well constrained at low structurally manageable levels. However, beginning in 1980, and as we have discussed in many past blogs, the economy shifted and interest rates began a very steady descent. This decline of interest rates led to a massive expansion of debt which ultimately sowed the seeds for slowing rate of growth in the economy.
The issue how is that we have entered into the “Japan Syndrome”. Almost 30 years ago Japan experienced their own real estate/credit bubble bust. Japan has attempted virtually everything the Fed has tried from lowering interest rates, liquidity injections and currency deflation in order to restart their ailing economy – it has all failed. As a result of these monetary experiments Japan has remained in a protracted economic slump.
The process of attempting to lower interest rates in a highly indebted economy is doomed to failure before it starts. The are only a couple of things that will work to restart the economy at this phase of the game: 1) Significantly lower tax rates and simply the tax code, and; 2) drastically reduce regulations on businesses. Even these steps won’t see an immediate return to economic strength as consumers must continue the deleveraging process of their own balance sheets and increase personal savings before they can return to historically stronger consumptive patterns. In turn, higher personal savings rates will lead to productive investment which will foster economic growth. Unfortunately, this isn’t being allowed to happen.
Today we are not only watching the Fed duplicate earlier failed policy, we are also witnessing President Obama unveiling another $457 billion “stimulus” that will raise taxes by more than $400 billion and add at least another half-trillion to our nation’s already massive $14.5 trillion debt. No one, that has the slightest bit of intelligence, believes that is the real answer to the problems that we face.
In reality, while the Fed still clings to failed Keynesian policies and the White House to failed “spend our way to prosperity” measures – the average American is slowly being sucked dry by declining wages and rising inflation. Those same policies combined with regulatory reform acts that are yet to be written, threats of higher taxes, poor sales and political turmoil have pushed businesses and entrepreneurs into defensive positions. Unfortunately, those entities and individuals also happen to be the only ones that actually have the ability to create jobs – not the government.
It is time to drive a stake into the heart of our problems – debt. The reality that we face today is not one of a monetary nature – it is purely fiscal. A credit induced boom has led to a massive period of malinvestment. We must now begin to realize that this is not a normal economic recession but rather a balance sheet recession. We must now do what is unthinkable for this administration – get out of the way and let the system clear the excesses. The process won’t be easy but eventually dawn will come, the vampires will fade into the mist and economic life can and will resume.