Scary times

On New Year’s Day, I wrote this post wherein I assessed my family’s financial situation. Like many of you, I determined that my family’s financial life had been sharply devalued. I had done the things that prudent Americans do to have the expectation of having a decent retirement only to find out that someone had pulled the financial rug from underneath us. I am likely doing better than most, but I am still wondering where half of the value of my daughter’s college fund went, particularly since I am now paying her tuition bills and other expenses.

We now have a new Administration and Congress. Congress is about to approve a stimulus bill with a price tag of $790 billion. President Obama claims it will add or save four million jobs. In addition, our new Treasury Secretary Tim Geithner is getting ready to spend the second half of the bailout that Congress hurriedly passed shortly before the last election. Meanwhile the Federal Reserve is looking for new weapons to deal with the financial mess. It no longer has the interest rate lever, as the bank discount rate is effectively zero.

One option the Fed has is to print money. They do not have to bother cranking up the printing presses. The U.S. dollar is a fiat currency, which means its wealth is not based on anything tangible, like gold. The Fed can simply declare that more dollars exist. Whoosh! They can use the money to do things like buy troubled bank assets. The money spent and obligated to try to solve our financial crisis is currently between two and three trillion dollars, depending on which news reports you believe. Bear in mind that Bush left office with about a ten trillion dollar federal debt. We are about to bump that up by another third in just a few short months.

All this money is to fix a problem that no amount of money may be able to fix. Frankly, even our best financial wizards do not really know what it will take to fix this crisis or the magnitude of its cost. There is the hope that if toxic assets can be taken off the books of financial institutions at least they will be able to value their assets with some accuracy again. If that happens then they will feel free to lend credit. Maybe. Whether these steps would actually cause the economy to rebound is unknown too.

During the Great Depression, President Franklin Roosevelt did not know whether his various initiatives would turn things around either. Neither does President Obama. The only imperative then and today is that government must so something. It cannot just stand back while millions join the unemployment roles. President Roosevelt created an alphabet soup of agencies that put people to work on worthwhile endeavors like the improving our national parks. Similarly, President Obama wants to put Americans to work rebuilding our society to fit the 21st century. Only we really do not know what the 21st century economy will look like. Perhaps we will know when we are done.

There are some unanswered questions. If the Federal Reserve can create money by fiat, doesn’t all this new money just devalue the dollars we already have? Could this be good? After all, if deflation is a problem, devaluing our money promotes inflation. We seem comfortable with inflation, providing it is in a manageable range. However, we are uncomfortable with deflation because it is toxic to growth. On the other hand, could all this new money ultimately scare off investors, who will be paid back in dollars that are worth less? Similarly, what happens if the U.S. Treasury puts new treasury bills on the market but not enough creditors snap them up? How do we turn things around then?

No one seems anxious to spend too much time thinking about these scenarios, of course. If realized they could become catastrophic, leading to mass unemployment and hyperinflation that would make the late 1970s seem nostalgic. It could lead the unraveling of society as we know it.

One hopeful sign is the value of the dollar. Logically it should not be rising against other currencies when our economy is quickly contracting. Yet it is. This is true in part because this economic downturn is hardly just a United States phenomenon. It is global. It may seem counterintuitive to give your money to the U.S. Treasury at times like these. Yet, in a world rife with instability, our government is perceived as the most stable in the world. If you think about it, this is understandable. We had one civil war but are unlikely to ever have another one. We have no neighboring countries interested in invading us. And as we witnessed on January 20th, we have a tradition of peaceful changes in power, even during times of great trial. In a very uncertain world, the survival of the United States government is a good bet. So if you have money under your mattress and it doesn’t feel safe there, why not loan it to the U.S. Treasury? Even at niggardly interest rates, it looks safer in the federal government’s care than in any other place. So it is likely that when the U.S. Treasury auctions off the next trillion dollars in securities, there will be buyers. Perhaps we can ride this thing out by acquiring massive new amounts of federal debt.

It is hard to know how much of this crisis was preventable and how much is just a result of moving from a 20th century economy to a 21st century one. It is clear though that much of it was preventable but government chose to either ignore the problem or actively exacerbate it. Americans emulated their government by living far beyond their means. For myself, I find myself less ideological and more pragmatic. I have no patience for any politician who cannot see past their ideology.

We need leaders capable of impartially evaluating the present and taking pragmatic steps to address our present problems. The good news is that we have a ruthlessly pragmatic president. The bad news is that the vast majority of the Republican Party, and a small minority of Democrats, remain slaves to ideology. There were just enough of these people to gum up this stimulus bill. This means that the stimulus bill is likely to be half a loaf, rather than a full one. Let us hope there is enough sustenance in this half a loaf to actually revive our economy.