Obama Stimulus Package

Copyright © 2009, Greenwich Financial Management Inc., a registered investment advisor.

Last week, we discussed the clouded economic policy legacy of the Bush Administration. Looking forward to the new administration, the outlines of what we can expect are becoming clear.

Despite fears that Obama would make radical or far-out appointments, his economic policy team appointments have been mainstream. His appointee for Secretary of the Treasury is Timothy Geithner, presently head of the New York Federal Reserve Bank. In that role, Geithner has been working closely with Fed Chairman Bernanke and the present Secretary of the Treasury, Henry Paulson. He has been in the trenches trying to keep the banking system from going bust.

Obama’s appointee for chief economic advisor is Larry Summers, who served as Chief Economist of the World Bank and as Treasury Secretary in the later years of the Clinton Administration, presiding over the federal response to the Asian financial crisis. He served as President of Harvard University from 2001 until 2006, when he stepped down owing partly to fury over remarks he made concerning women in science.

Understandably, President-Elect Obama has focused on a plan to stimulate the economy. As the Target Fed Funds rate has approached zero, while key gauges of economic activity and payroll employment continue to fall, it has become apparent that low interest rates alone will not be enough to revive the economy, particularly while banks continue to shun lending. We are potentially falling into what economist John Maynard Keynes called the Paradox of Savings. According to Keynes, if consumers respond to a threat of recession by saving more, they reduce aggregate demand and worsen economic conditions. Under such conditions, Keynes advocated government deficit spending to reflate the economy.

Deficits we will have. According to Obama Administration officials, trillion dollar plus deficits are likely for the next several years. These will dwarf recent federal deficits, which were $162 billion in 2007 and an estimated $455 billion in 2008. Areas targeted for stimulus including tax cuts for individuals and enterprises, plus spending on
infrastructure, education, medical care, extension of unemployment insurance, and (apparently) rescue of the US auto industry. As I have argued in recent columns, in our planning, we should strenuously avoid having the government choose winners and losers in business competition, whether that business is energy, autos, green technology, or anything else. We also need to guard against the notion that government will not allow massive companies to fail.

There are several real dangers stemming from the massive stimulus package. The first is that the stimulus will be mis-timed. That is, spending will come in too late and continue too long, or even indefinitely. Once government starts new programs, or expands existing ones, it’s difficult to rein them in. Second, there will likely be great waste, especially if funds are put out in a hurry. If you need a case study of such losses, consider the government contracting process in Iraq. Third, there is the danger that the stimulus, if carried on too long, could fuel inflation, balloon the federal deficit, damage the dollar and create an undue burden of repayment for future generations.

However, sometimes a lack of boldness is as much of a risk as audacity. To head off a deflationary spiral, President-Elect Obama has elected to take drastic measures, of which we will probably learn more through his inaugural address. For now, sentiment favors President-Elect Obama’s bold thinking.

Andrew Szabo CFA is managing director of Greenwich Financial Management Inc., a registered investment advisor. Questions call 917-796-8500 or e-mail Szabo@GreenwichFinancial.com). For more information, please visit http://greenwichfinancial.com/.