FYI | Dec 04 2008
By Greg Peel
As at the end of November the US government had endorsed spending programs worth US$4.16 trillion to bail out Wall Street and the US economy.
It seemed not that long ago that we were marvelling at the concept of a billion dollars – an amount seemingly too large to contemplate – but the twenty-first century has given us the concept of a trillion dollars. We once considered that to be fabulously wealthy was to be a “millionaire”. Now half the people in Sydney who own their own home are millionaires. To boast stand-out wealth one must now be at least a “multi-millionaire”, and to be at the upper end of the scale one must now be a “billionaire” – the equivalent of a millionaire a thousand times over.
In simple terms (and using the accepted US numbering system) a million is a thousand thousand, a billion is a thousand million, and a trillion is a thousand billion, or a million million. To put that into perspective, if you stacked fresh, new US $1000 bills on top of each other, a stack worth US$1 million would be 109 millimetres high. A stack worth US$1 billion would be 109 metres high. The stack would reach about a third of the way up Sydney’s Centrepoint Tower.
The stack of US$1000 bills needed to equal US$1 trillion would be 109 kilometres high. The Earth’s atmosphere reaches out about 120 kilometres from the surface.
It all became Monopoly money numbers as 2008 progressed anyway, as the US Treasury and Federal Reserve announced one program of lending and stimulus after another. The US dollar is, after all, the world’s reserve currency, and it is only really an IOU. There is no hard commodity – such as gold – providing the currency with collateral, only the US economy. Holders of US dollars must simply be confident the world’s largest economy can keep growing over time to support the value of those dollars. If not, the US dollar could go the same way as the Zimbabwe dollar.
But Zimbabwe is at the other end of the scale, effectively having no economy. The US economy is in recession – possibly the worst recession in 25 years – but it’s happened before and the US economy has survived, with the help of the US Treasury. Indeed, large US government spending plans of the past were implemented on collateral-backed dollars, including the Gold Standard period between the Second World and Vietnam Wars.
In an interesting exercise, the website Voltagecreative.com decided to compare past massive US spending programs with that of the 2008 bail-out by adjusting into equivalent 2008 dollars. The website identifies nine stand-out amounts, to which one might ascribe the description “massive”, over the last couple of hundred years.
The first is the Louisiana Purchase of 1803, when a fledgling republic bought about a quarter of the land that is modern day mainland USA from the French. That land now encompasses 15 states and forms the bulk of the Mid-West. Its cost was US$217 billion of today’s dollars.
Jumping into the twentieth century, Roosevelt’s New Deal of 1933 was that era’s package designed to provide relief from the Great Depression, and cost US$500 billion. The Marshall Plan, in which the US provided funds to rebuild Western Europe after the Second World War and bolster it against the rise of communism, cost US$115 billion.
On the same theme, the Korean War cost US$454 billion and the Vietnam War US$698 billion.
Putting a man on the Moon cost the US US$237 billion, and when you add in the rest of the complete NASA budget since its existence that’s another US$851 billion.
Now remember – these are all figures in today’s dollars, not the dollars of the day. They are all massive programs, but as yet not one has exceeded the trillion dollar mark, let alone four trillion.
The last similar rescue of the US economy to the latest one was the during the Savings & Loan crisis of the early nineties, for which the US spent US$256 billion. And then, of course, there is the ongoing Iraq War, on which the US has to date spent US$576 billion.
Not one of those programs exceeds one trillion US dollars. In fact, if you add them altogether, they total US$3.925 trillion. In other words, if you add all of the most notable US government spending programs over the last 200 years together you still don’t get to the US$4.16 trillion mark spent so far in the 2008 Wall Street bail-out.
Gotta love that leverage!
One must also remember that the US entered the credit crisis with both a fiscal deficit and the biggest current account deficit in its history. It is simply a borrower who needs to borrow more lest the original amount never be paid. But will the US government ever pay back US$4 trillion in the foreseeable future? No way. That is a problem for distant future generations. It’s not about paying the money back, its just about keeping up the interest payments. And what has happened to value of the US dollar since the world collapsed in October? It has risen. The world has been putting its hard-earned money into the “safe haven” of US government debt. Go figure.
So what is the plan from here? To spend more money of course. New initiatives were announced only last week, there’s still a matter of the auto industry to deal with, and Barack Obama has promised a huge fiscal stimulus package as soon as George Bush hands over the keys. Citigroup has been bailed out, and no doubt we’re yet to see the bitter end of such rescues.
The US$4 trillion dollars is intended to save the US economy through stimulation, but stimulation implies that the money the government pumps into the system is then on-spent. An economy can only operate and thrive if one amount of money is passed continuously from one set of hands to another with benefits gained at each step. As soon as the money stops moving – or loses its so-called “velocity” – the economy stagnates and then begins to contract. The money will stop moving if one party decides not to spend it, but rather hang on to it for safety instead.
The US$4 trillion total is the culmination of measures taken by the Fed and Treasury to attempt to stimulate the economy since right back when the first “shock and awe” 50 point rate cut was made in August last year. That “shock and awe” now seems quite pathetic. The usual way for an economy to be stimulated is to make the cost of money cheaper and let the private sector do the rest. But the Fed funds rate is now at 1%, down from 5.25% and the US economy is in even worse shape. The reason is that everybody – from the banks down – is hoarding the money the government has been handing out rather than spending it.
It is also the problem now facing a once complacent Australian government as it prepares to hand out “stimulus cheques” to Australian consumers. If Australians do what they have always done and take that money straight to Harvey Norman et al things will be fine. They could even blow it on the pokies or over the bar, but at least the money would keep moving. Those proceeds go into, amongst other things, staff salaries and it is they who can then go to Harvey Norman, and so on down the line.
But if Australians do the unthinkable and actually save that money, or use it to pay down debt, then they will be doing exactly the wrong thing at this time even though the government now wishes they had done a bit of that all along. The time to save or pay down debt was at the top of the cycle, not the bottom, which is why the RBA put rates up to 7.25% as a disincentive.
To draw upon the popular culture, this problem has now given birth to “Glovernomics”. Claiming all but total ignorance of economic theory, ABC Sydney radio announcer Richard Glover has ingenuously thrown up an idea that the money about to be handed out by the government should carry a use-by date before Christmas. In other words, the money must be spent. But wherever it is spent, that shop or service must spend it again lest they be stuck with a worthless asset. And so on the money would go like a hot potato. No one would save it for another day. The result can only be economically stimulatory.
Except that some poor mug would get caught with a loss at five minutes to midnight. Listeners have offered ways to improve the plan, such as offering the “money” at a premium value on Day One that amortises to face value at expiry. Let’s just say, for example, that a $50 note is worth $70 when you get it and then ticks down towards $50 each day. You would then have the incentive to spend the money as fast as possible, and this incentive would mean as many people as humanly possible would re-spend the banknote before Christmas, achieving maximum “velocity” and thus maximum stimulation.
The theory’s all just a bit of fun of course, but Glover insists he has yet to have anyone of sufficient economic credentials tell him why it’s a stupid idea. Someone pointed out that the plan has already been implemented in Zimbabwe, but circumstances are a little bit different there. A Zimbabwe dollar otherwise collapses in value in the time you stand in a queue for bread.
The US cash rate has now reached as low as 1% in order to stimulate investment, but to no avail. It could easily go to zero, but for obvious reasons could go no lower. Despite two full percentage cuts in one hit in the last two months, at 4.25% the RBA still has room to cut further and achieve monetary stimulus. Fed chairman Ben Bernanke this week admitted, however, that while a 1% rate still allowed room for further cuts, the efficacy of such cuts has now diminished. How much difference is another 1% going to make? And that’s the end of the line. The Fed is thus forced to implement monetary policy through different means.
What Bernanke has suggested is that instead of trying to stimulate the short end, only to see banks hoarding the funds, it will move to stimulate the long end, by buying US Treasury bonds. The result is the yield on the US ten-year bond has now fallen to below 2.75% – its lowest level in decades. The market rushed in to buy bonds before the Fed did. But Bernanke’s hope is that if longer-dated debt such as mortgage debt becomes cheaper, the economy could be stimulated from that end instead.
In other words, the US Treasury will be borrowing more money not only from the rest of the world, but from the US Federal Reserve as well. The Fed doesn’t really have any of its “own” money, it just controls flows between the public and private sectors.
If this recession doesn’t reach the giddy heights of the Great Depression, I hope I’m not around for the next one.
