So, most people by now have heard that the Fed is going to go to pursue a zero interest rate policy or something close to it. That's all well and good, but it won't make a dime's worth of difference. With the current chasm between aggregate supply and demand growing all the wider, consumers already in debt up to their eyeballs, and banks unwilling to lend, it doesn't matter how cheap money is. As demand collapses and prices go in to free-fall, interest rates are increasing in real terms, even as the nominal central bank discount rates around the world are slashed close to zero.
In short, we're in a liquidity trap, an environment in which measures to stimulate the economy by directly increasing the money stock on the supply side can't possibly be effective. Since investors are fleeing to the relative safety of treasuries and yields dropping through the floor, standard open-market operations in which the Fed prints money and buys government debt with it have no effect, as they're just swapping one zero-interest rate asset for another. The effect of this is very bad indeed - we're headed toward a depression even more severe than the Great Depression unless something is done, and I mean now. If the lame-duck Congress and Hank the Destroyer over at Treasury keep trying to apply band-aid solutions in the form of bailouts for distressed firms until Obama takes office, far-reaching damage will already have been done. Bailing out distressed banks and automakers while demand is falling off a cliff is rather like giving blood transfusions to a patient who has an arterial hemorage - it might buy you a few minutes of life, but it sure doesn't solve the problem.
What Needs To Happen
Fortunately, I think there's still time to prevent a severe depression - not a bad recession, but at least a depression. Unfortunately, I have no confidence that our political leaders will bite the bullet and make the hard choices necessary to avert such acollapse, at least until it's too late. Here are a list of policy actions that must be taken immediately (but probably won't):
- A moratorium on all foreclosures of indefinite duration, with a floor time of at least one year.
- A provision of unlimited liquidity to solvent financial institutions.
- An immediate freeze on rate hikes for all secured and unsecured variable-rate consumer debt.
- A rapid reduction in the debt burden of insolvent households via a swap program to allow financially distressed households to reduce and refinance credit card and mortgage debt at longer term and at sensible interest rates (say, 10-year T-bill yield + 3%). In exchange, consumers must agree to limit future indebtedness to a sensible percentage of income.
- An optional program that allows retirees and workers close to retirement to exchange equities and investment-grade bonds in IRA's and 401k's for government debt at a premium (e.g., average price over the last year) in order to partially halt panic selling.
- An immediate guarantee of corporate pension liabilities for all current retirees and workers nearing retirement.
- A temporary, emergency provision of government-sponsored health insurance for all unemployed and uninsured citizens, to be followed later by the development of a sensible universal health insurance policy.
- Most importantly, a massive public works program (something on the order of $1 trillion, minimum) to tackle climate change, rebuild dilapidated infrastructure and dramatically reduce US reliance on foreign energy sources.
To summarize...
In accounting terms, these policy actions will be extraordinarily expensive; and yet, the fiscal, economic, and even security costs of inaction will exceed those costs by many orders of magnitude.
In normal times, I'm a huge deficit hawk, but when the market economy starts working in reverse - destroying wealth and jobs rather than creating them - the standard rules are inverted. Fiscal restraint becomes a vice, profligacy a virtue. With wise leadership, these policy actions will more than pay for themselves over the long run. We should err on the side of extravagance too, because in this environment, it's much better to risk over-doing things. The Fed can easily step in and raise rates if the economy starts overheating. Let us also remember that the overall threats to prosperity have been flipped in recent months; the deficit is no longer a pressing concern, as US government debt is the only thing investors around the world want to buy. Treasury yields are dropping like a stone. The risks to dollar strength and inflation, at least in the short run, have completely evaporated at this point.
There is no time to waste. On our current trajectory, the CPI could decline 5% this month and 10% in December; another three months of inaction and it will be too late to avert disaster. It's time for Congress and our lame-duck, lame-brain President to cut the childish political bickering and the ideological feuds, step up to the plate and earn their six-figure salaries.
By the way...
Ron Paul acolytes, purest conservative and libertarian ideologues, gold-bugs, and other assorted clowns - please take your yammering elsewhere. This mess is not the fault of the CRA, nor Fannie Mae, nor the FDIC (an especially stupid claim that's been making the rounds as of late), nor Barack Obama, nor Barney Frank, nor any of the other human punching bags Blowhard Bill blames in the daily Two Minutes' Hate on the Fox News Noise channel (though I will say that the Fed is a different story). If you feel you must pollute my comments section with such stupidity, please also describe how you managed to graduate junior high, as the math required to substantiate such assertions doesn't even come remotely close to adding up.
Cross-posted at my new blog, DailyElitist.com.