Bad Medicine is Killing the Economy

Bad medicine is killing the economy. As I have said before, allowing political ideology, politicians, pundits, and a.m. radio hosts influence or dictate economic policy for the U.S. is absolute folly. Let me go one step further. It’s like having a someone who reads WEBMD prescribe medicine; what we’ve been doing is letting that person treat the flu with one round of antibiotics after another, and it’s not helping. It may, in fact, be making matters worse.

This Patient Desperately Needs a Second Opinion

The wrong diagnosis, followed by the wrong treatment is being practiced in order to cure America’s sick, but still salvageable economy. In most cases, politicians have simply made a bad diagnosis. This is the predominant case for politicians that actually care about the welfare of the patient (the U.S. consumer).

In other cases, politicians don’t care about the patient, they just want to see as many patients as possible, give them something that sounds smart, and charge them as much as possible. Since this current crisis manifested (that was caused by manipulation of our economy by people that do know how it works), the treatment policymakers have prescribed is tantamount to experimental medicine with potentially severe side effects.

Recent data on consumer spending in the United States has been dreadful. Growth in inflation-adjusted US personal consumption is down to 1.5% in the second quarter of 2012, and appears to be on track for a similarly unremarkable increase in the third quarter.

The malady is a protracted balance-sheet recession that has turned a generation of America’s consumers into the equivalent of the economic walking dead. The corporate zombies of Japan in the 1990’s that enabled the first of Japan’s lost decades have now infected the US economy.

In the U.S., two distinct bubbles, property and credit, facilitated a decade of extreme over-consumption. Since their meltdown in 2007, US households have justifiably become fixated on repairing the damage. That means paying down debt and rebuilding savings, leaving consumer demand mired in long-drawn-out weakness.

Yet the treatment prescribed for this malady has compounded the problem. Since Congress has become a breeding ground for self-centered slime-balls, The Federal Reserve felt the need to do something, anything, but opted for treating the disease as a cyclical problem. As such, The Fed has been attacking the problem with the full force of monetary stimulation by easing interest rates to offset what is clearly thought to be a passing and temporary reduction in total consumer demand.

But the logic driving this treatment is simply flawed in that it’s for the wrong disease. There is nothing cyclical about the prolonged aftershocks of a balance-sheet recession. Balance-sheet repair has barely begun for US households; the personal-saving rate stood at just 3.7% in August 2012. This is a significant increase from the 1.5% low of 2005, but about half of the 7.5% average documented for the last thirty years of the twentieth century.

Worse, the Fed’s chosen prescription is further weakened by the zero bound on interest rates. Having run out of basis points to cut from interest rates, the Fed has turned to the quantity measurement of the credit cycle by injecting gigantic doses of liquidity into the collapsed veins of zombie consumers.

To rationalize the value of this methodology, the Fed has modified the prescription by way of unrestricted monetary policy. Unlike in past recessions, when cutting the price of credit could boost borrowing, “quantitative easing” allegedly works by stimulating asset and credit markets. The feeling of wealth effects generated by superficial financial markets are then presumed to revive long-dormant consumer demand, irrespective of persistent balance-sheet damage.

Apparently the thinking is that once the demand problem is cured, companies will start hiring again.

By ignoring previous failures however, the Fed’s policy has doubled down on an approach aimed at recreating the folly of an asset-and-credit-dependent consumption model which is exactly the blunder that pushed the US economy toward the previous “fiscal cliff”  in 2003-2006.

But again, this is the wrong medicine for the disease. Major central banks, the Fed, the European Central Bank, the Bank of England, and the Bank of Japan have infused substantial amounts of excess liquidity into asset markets. Liquidity that cannot be absorbed by lethargic economies suffering from anemic consumer demand.

The Worst of All Worlds

The worst possible tactic was, and is still being tried in Europe. Austerity in the middle of a consumer demand contraction of the magnitude we are seeing is like pouring gasoline on a fire…then adding a stiff breeze to it. The more people are out of work, or even under the threat of possibly being out of work, the more they hoard. Like it or not, the debt is not causing the contraction…the contraction however is exacerbating the slow pay down of the debt.

I’ve run out of ways to say that this is the worst possible strategy. It’s like throwing an anchor to a drowning swimmer instead of a life jacket. Actual fiscal stimulus, regardless of how distasteful Republicans pretend such a strategy to be, is exactly what is needed…AT THIS PARTICULAR TIME.

Successful economic stratagems are implemented in full. Austerity is fine, but must be more than a political ploy to win an election. It must be a permanent strategy. Keynesian economies are also fine, but must also transcend political cycles.

Simplistically, Austerity is conservative in nature. Save revenue and create a reserve capacity in order to have it when needed in the inevitable downturn that happens in all economies. Conversely, Keynesian policies dictate  stimulating the economy during downturns to get the economy going, but when the economy picks up and people are employed and surpluses are achieved, use those surpluses to pay down debt incurred during the same inevitable downturns.

It’s the herky-jerky, back and forth, one-then-the-other nature of political cycles and the desire for politicians to implement their chosen fiscal philosophies whenever in power that has led to our economy mired in a jumbled mess and verging on collapsing the global economy.

Politicians, fiddling with the economy in order to win elections is killing the economy beyond repair.

As the global economy has gone from crisis to crisis in recent years, the cure has become part of the disease. In an era of zero interest rates and quantitative easing, macroeconomic policy has become unhinged from reality.

And unproven medicine is being used to treat the wrong ailment. The doctors will not be the ones to suffer while the patient dies. It will be the American economy.

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