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Stimulus Spending - A Failed Model

Paul Krugman wrote an article last week entitled That ’30s Show, in which he claims that the recent loss of jobs demonstrates beyond the shadow of a doubt that the stimulus is not big enough.  He further rants about lack of cooperation being unhindered by facts or logic, and takes to task other economists for perpetuating the myths of bad consequences stemming from “short term deficits”. 

I bring this up to ask a simple question.  Can stimulus spending fail?  Mr. Krugman and others are presenting an infallible approach to an economic problem - spend a lot of money.  Why infallible?  Because the claim being put forth is that the ONLY way for this stimulus to fail is by being too small.  That’s it.  No alternative. 

Nevermind that massive amounts of capital are sitting on bank books, unused.  Nevermind that the $168 billion (remember that little program?) sent to taxpayers last fall made hardly a ripple.  Nevermind that the extra $13/paycheck that so many now enjoy (too strong a word, I know) is being used to pay down or just service debt.  Nevermind that the rate of delinquency on loans (mortgages, revolving credit, installment) continues to go up as many consumers face the reality of being inescapably underwater precisely because they lived well beyond their means.

 It is obvious to Mr. Krugman and apparently anyone with synapses firing that we simply need to replace some of the lost private spending with government spending until…oh, that’s right.  There is no “until”.  There are only phrases like “back on track” and “return of consumer confidence”, but those words are misconceptions.

For stimulus spending to work it must, well, stimulate something.  Our current economic condition was brought on by a tremendous amount of personal consumption that was financed through borrowing, both collateralized (home equity) and uncollateralized (credit cards).  Home equity lending took the form of cash out refinancing, but a zero-down purchase is also something of a home equity loan, in that it allows the transaction of the home purchase but does not require the traditional 20% of purchase price saving by the borrower.

As Boomers went through their highest spending stage of life they did themselves proud, spending with abandon.  Financiers were only too happy to come up with new ways to feed the frenzy.  But times have changed.  The ever-increasing amount of debt we were willing to shoulder became too much.  The spenders are 1) tapped out, unable to take on another dollar of financial burden against future income, and 2) turning into savers, as they move to the next stage of life in which they, as empty nesters, prepare for retirement.  As this happens, there is no way around the fact that a reduction in debt means a reduction in consumption, which means a reduction in economic activity.

So we return to the notion of, “Stimulate what, exactly?”, because the only way to return to yesterday’s level of economic activity is through a return to ever-increasing levels of private debt.  Know anyone itching for a bigger mortgage?  Me either.

The stimulus spending will have an affect, no doubt.  We have already allowed states to return somewhat to their status quo by partially filling their budget holes, and we have allowed national politicians to feed the notion that there really can be “something for nothing”.  Unfortunately, we all know that these debts must be paid, and someday we will have to adjust to live within our means.