This from Money Morning:

The British government this week unveiled a stimulus plan that will boost that country’s budget deficit to $181 billion (118 billion pounds), the equivalent of 8.0% of gross domestic product (GDP). U.S. President-elect Barack Obama’s stimulus plan, when combined with the recession, may raise the U.S. federal deficit to $1.2 trillion, or 8.0% of U.S. GDP.

This raises the question: If it’s so easy to stimulate an economy, why don’t we do it all the time? Don’t such large deficits cause problems?

The 4-1-1 on Stimulus Packages

There is no question economic stimulus is popular. Economist John Maynard Keynes originally proposed it to counter the Great Depression, and it is now used as a panacea every time the economy suffers even the mildest hiccup. The Economic Stimulus Act of 2008 – a $150 billion stimulus the Bush Administration unveiled last spring – is an example of this: It was proposed before the economy had suffered a negative quarter and it provided a modest short-term blip to consumer spending, making the second quarter of 2008 the best of the last four.

It also increased the federal deficit by an estimated $152 billion. And it did nothing, whatsoever, to solve the problems of housing finance failures, bank illiquidity and deep recession, though it may have postponed the actual onset of recession for about three months – the sharp downturn appears to have begun in July, the month after the stimulus package ended.

There are two reasons stimulus packages are popular:

• Politicians like excuses to spend more of our money.
• And the public is made to think that they are bound to work, because politicians and the media promote it as a one-sided thing. So, it seems obvious that if government spends more money – or cuts taxes – the economy is bound to improve.

When One’s a “Crowd”

What people don’t realize is that the money has to come from somewhere. Take Spain, where the government had previously been running a budget surplus. In such a case, a stimulus package is unlikely to do much damage, because it will cause only a modest deficit.

If, as is normally the case, the capital market is flowing freely, with investors worldwide buying U.S. bonds, then borrowing money for a stimulus package would at least do little harm, because capital inflows into the United States will just increase commensurately, so worthwhile projects still will get financing.

However, if the capital markets are even moderately tight (and they are more than moderately tight at present), then a stimulus package can be very damaging – perhaps even doing more harm than good. If it consists of extra spending, then the borrowing that’s done to finance those expenditures will “crowd out” private sector spending or investment. The sponsors of the stimulus package had better be very sure that their spending is well directed.

Keynes’ favorite scheme – employing people to dig holes only to fill them in – would make matters worse, not better. In the world of government budgets, the “hole” is deficit spending. The deficit is filled in – financed – with borrowed money.

Unfortunately, the money borrowed to fill in the budgetary hole would make matters worse, not better, because the money the government borrows would result in less money being available to invest in the rest of the economy. The little bit of money that was left over for private sector players to access would, naturally, command a higher interest rate, making the additional investments much more costly.

With a government-spending stimulus, nobody can be sure what is optimal, because the market is not involved, and government, once increased, may be very difficult to rein back.

Last spring’s tax-rebate stimulus package probably made things somewhat worse.

The tax rebates were spent by the recipients, who devoted their resources in ways that, at least to them, seemed optimal. But there is no long-term increase in the size of savings because U.S. consumers already save too little for economic health. So, draining some large portion of $150 billion from the savings pool to feed additional consumption was not sensible.

One other point regarding the tax-rebate stimulus: There is a school of thought – espoused by the folks who produced the acclaimed documentary “I.O.U.S.A.” that these rebates, by significantly slashing the government’s revenue, badly exacerbated the country’s debt burden.

British Prime Minister Gordon Brown’s Nov. 24 stimulus package involves primarily a temporary reduction in Value Added Tax (equivalent to a sales tax). At first glance, that was a surprising move, since the British government is from the left-of-center Labor Party. However, the reality was that after 11 years of Labor Party leadership, the budget was way out of balance even at the top of a boom, and the public had grown very tired of Labor’s public spending excesses – hence a “stimulus” of yet more spending would have caused even the placid British to start throwing things.

Obamanomics 101

President-elect Obama’s economic advisor, Austan D. Goolsbee, stated on Sunday that the stimulus “had to be a big number in order to get people back on track and startle the thing into submission.”

That is a little alarming, because the resulting budget deficit could startle into submission the bond markets as well as the recession. That would cause a flight from U.S. government debt and the dollar, reducing U.S. living standards, raising interest rates and possibly even causing the rating agencies to downgrade U.S. government debt.

A stimulus package of $1 trillion, the high end of what has been mentioned, would almost certainly be too much – especially since it’d come after the Treasury Department’s $700 billion Troubled Assets Relief Program (TARP), which is fueling bank takeovers, and not expansionary lending, and the follow-on $800 billion credit-market stimulus unveiled yesterday (Tuesday).

On the other hand, Obama plans a middle-class tax cut, which gives the money to those who have least benefited from boom of the past few years (prior to the financial crisis) and keeps it away from Congress’ profligate spending barons who would waste it on bridges to nowhere and other pork-barrel projects.

Furthermore, Obama’s healthcare plans and New Energy investment plans have both been blessed by the electorate, so presumably people actually want them. Moreover, he is talking of spreading the stimulus over a period of 2 years, which would presumably reduce the immediate borrowing requirement and ensure that the economy was genuinely into recovery before the stimulus ran out.

The market currently wants a stimulus package and trusts President-elect Obama. He thus has a major opportunity to implement some of the spending plans he favors, while keeping the market happy. That’s a rare opportunity, but he should be careful not to take for granted the market’s welcome.

Source: Government Stimulus Programs Not Always the Hoped-For Panacea

More from Charles…

If we’re in a recession, why did second-quarter GDP show a 3.3% climb? Does that mean the recession is over? Not so fast.

There are two big reasons why second quarter GDP moved higher. And these are two reasons that won’t be around so much in the third quarter.

The first reason why GDP moved higher was government intervention. A massive $152 billion stimulus plan hit the market during the second quarter. This boosted consumer spending and helped prop up the GDP. But this was a onetime event. There aren’t anymore stimulus packages planned, which means that consumer spending should drop again.

The second reason why GDP moved higher had to do with faster export sales. With the dollar dropping so much this year, it’s no shock that exports moved higher. This export growth will slow, though. The economies in Japan, Germany, England, and a host of other European and developed nations are shrinking. This will place less demand on US exports and we should see export growth slow.

As you can see the two things propping up GDP growth in the US shouldn’t be a factor during the third quarter.

Growth will still be sluggish to nonexistent and the economy will continue to deal with higher than average inflation.

Source: Don’t Get Fooled by the 3.3% GDP

The Daily Reckoning’s Chuck Butler has a less positive interpretation of the growth data, which he says is a blip on the downward path to recession. First, here are some more details from Forbes.com:

“The second quarter revision was well above the 2.7% average prediction from economists polled by Thomson Financial.

The faster-than-expected growth came off the back of rising exports, which were helped by the weak U.S. dollar, falling imports, more consumer spending and less inventory reduction than initially reported, the Commerce Department said.

“The increase in real GDP in the second quarter primarily reflected positive contributions from exports, personal consumption expenditures (PCE), federal government spending, nonresidential structures, and state and local government spending,” the department said in its report. Commerce also noted that imports, which subtract from GDP, were revised lower.”

Chuck wasn’t surprised by the elevated reading. A plunging dollar and the government’s stimulus checks are behind the upward revision. And neither will apply to data for Q3…

“Front and Center this morning I have to talk about the blip that we’re going to see that happened in the 2nd QTR due to the stimulus checks. It all goes back to the stimulus checks and the first sign of this came (besides Retail Sales) yesterday in the form of Industrial Production. Remember yesterday when I told you that Industrial Production is a second tier piece of data that gets ignored by the markets, but I think it’s important so I talk about it? Well… Just like last week, when I described the bratty spoiled child throwing a tantrum on the floor of the grocery store as being something you can’t avoid paying attention to… The growth in Industrial Production was the same…

Industrial Production for July came in strong, and rose 1.3% in the month and compared to expectations of a no change. The June increase was revised up to 1.3% from an initially estimated gain of 0.8%. And… The good news about this data is that the growth was led by non-defense spending! WOW! When was the last time that happened? Anyway…. The stimulus checks have their fingerprints all over this report…

And so too will they have their fingerprints all over the 2nd QTR print of GDP today. I told you Monday that to expect a blip up in GDP, which will stir the interest rate hike pot once again, and probably give the dollar some love. One thing to think about here, because the dolts in the media won’t even think about it, they’ll just drool all over the size of the GDP growth, is that I expect exports to have contributed to the 2nd QTR GDP by a sizeable margin, for what was happening to the dollar in the 2nd QTR? It was getting sold like funnel cakes at a State Fair, and getting weaker, and weaker, which just made exports look cheaper and cheaper, thus giving them a huge boost.

But what’s happened since the end of the 2nd QTR? The dollar has rallied, so don’t look for that boost to GDP in the 3rd QTR… And don’t look for the boost to GDP in the 3rd QTR from the stimulus checks… Those have already been spent! So… The 2nd QTR is going to end up being a blip on the recession chart when the historians look back on this period of time. But… That means, dollar strength, folks… Because, even though the markets normally are “forward looking” they will get so caught up in this 2nd QTR GDP growth that they will lose their focus.”

To read more of Chuck’s currency analysis today, click here.

Questioning The Fed’s Rhetoric…

Good day… And a Happy Friday to one and all! It will be a Fantastico Friday (Hopefully) for the boys and girls in the St. Louis office, as we head to Busch Stadium tonight for a Cardinals baseball game… We even have a special guest that will be with us, so party on Wayne… Party on Garth!

Well… Things went a little crazy on the desk while I was away yesterday… When I returned home last night, I had a ton of emails from the Big Boss, Frank Trotter, and that’s usually a sign that things didn’t go well! Frank plays hockey on Friday mornings, and said he will call me to bring me up to date on his way to hockey…

The Big news in the currencies is that the dollar is on a roll… And is not taking any hostages! All this talk about higher interest rates in the U.S. has the dollar bulls giddy, and has really turned the negativism that had crept back into the dollar’s camp last week at this time, to be swept under the rug… You know me, I’m going to get on my soap box and rant about this dollar strength… So here goes…

The dollar rallied after hearing the news of the Retail Sales print… But as Chris told you yesterday, this was a one and done for Retail Sales… Yes, I know that some tax checks didn’t arrive until late in May, I would imagine those that arrived late, were offset by people in dire straits financially, that could not go out and buy that plasma TV!

Here’s Chris Gaffney’s take on the Retail Sales data… “I read a couple of articles which touted the American consumer’s resilience in the face of everything negative. I just can’t understand how consumers continue to borrow and spend. But how will the Fed keep the consumer happy going forward? I don’t think they have any more stimulus packages to pull out of their hat (although I read where Barak Obama is already calling for a second one). I still feel the next bubble to pop will be the consumer debt bubble which is reaching record levels. As consumers declare bankruptcy and walk away from their debt burdens, banks will again see massive write downs of their portfolios and the credit crisis will again be front and center on everyone’s minds.

But while currency traders are pricing in a FOMC rate increase sometime this year, economists are cutting their US growth forecasts for this year and next. They now project that quarterly growth will not exceed 2 percent through 2009. Soaring food and fuel prices, tougher lending rules and job losses will continue to hurt consumers. The weaker outlook means the Federal Reserve will forego raising interest rates until next year to combat inflation. Once this becomes more clear to the currency markets, the dollar will give back all of its recent strength.”

There was more bad news in the markets yesterday as Citgroup decided to close Old Lane Partners, a hedge fund co-founded by CEO Pandit that the firm bought for over $800 million less than a year ago. This is just another in the line of mistakes that banks have made with regard to hedge funds….

Well… In the “I told you so” compartment, I see that Lehman Bros cleaned house with their leaders yesterday. This was after posting some huge losses last quarter… You many recall me saying this would happen… But if you don’t… Let’s go to the tape of the June 3rd Pfennig when I said… “… It wouldn’t surprise me one iota if long after Lehman announces that loss that another “change” is announced…”

The markets are sweeping all this bad news under a rug folks… And you know me, I learned long ago that you can’t fight the markets… But you can call them DOLTS! I guess all this bad news isn’t “bad enough”…

The markets are all “jacked up” on the Fed’s rhetoric about “fighting inflation”… Which the markets take as interest rate hikes… But when? Next year? Oh, so you should give up the positive rate differential that the euro, Norway, Sweden, U.K., Australia, Brazil and others have VS the dollar because the Fed MIGHT raise rates in the next year? Shame on you all you pundits out there telling people these things about rate hikes in the U.S.!

Listen to me now, and hear me later… THE FED ISN’T GOING TO RAISE RATES! The ECB IS, but the Fed ISN’T! At least not for sometime, THE ISN’T GOING TO RAISE RATES! Did you hear me? Oh, just in case you were busy listening to someone on CNBC tell you that everything is beautiful, I said… THE FED ISN’T GOING TO RAISE RATES!

Over at CitFX, the researchers there put together a great commentary yesterday that our old colleague and Corporate FX guru, Ashish, sent along to me… The researchers at CitiFX thing this whole “interest rates are going higher in the U.S.” is a crock… The point out that the PCE (personal consumption expenditures) that is supposedly a fave indicator of inflation of the Fed’s was 2% last July before the sub prime meltdown… It now sits “drastically higher ?????” at 2.1%… So, where’s the emphasis to hike rates here?

They also point out that “we are looking at the only 3 severe economic downturns of the last 30 years and possibly the 4th now. The prior 3 were all jump started by a corrosive asset price fall (housing in 1979-1981 and 1989-1991 and equities in 2000-2002). In all 3 instances there were all preceded by an Oil price surge, which exacerbated the drag on the economy… And all 3 say massive easing cycles from the Fed lasting 18 months, 39 months, and 29 months respectively. (average 28 months)

They other thing they point out is that when unemployment rises, the PCE falls…

So… I’m not the only person screaming at the walls here, that the Fed’s rhetoric is empty, and can’t believe the markets have swallowed this hook, line and sinker!

One person not buying into this dollar strength (I’m told) is Pat Robertson. I didn’t hear this… But I was told that Pat Robertson of the 700 club said on his program that is followers should “get out of the dollar”, which is fine… But the important thing he said was to invest with EverBank!

One bank that did raise rates yesterday / last night was the South African Reserve Bank (SARB). This is the 6th rate hike in the past year… Other rate hikes helped push the rand higher VS the dollar, but I doubt this one will, given this mental brain drain going on in the markets right now…

So… We head into the weekend on a very sour note for currency holders… I said a few weeks ago, that we might have to deal with euro weakness, which leads to other currency weakness as the euro is the Big Dog, for some time to come… I even said that this could much like 2005, when the dollar rebounded, on the Fed’s rate hikes… But sooner or later, love is gonna get you, no wait! Sooner or later the traders all eventually come back to the underlying fundamentals…

The headline-grabbing refund checks, part of an economic stimulus package passed in February, will go to roughly 130 million US households and will range in value from $300 to $1,200.

According to President Bush: “The money is going to help Americans offset the high prices we’re seeing at the gas pump, the grocery store, and also give our economy a boost to help us pull out of this economic slowdown.”

“The Bush legislation includes a provision that offers generous tax credits to individuals who buy homes out of foreclosure,” says Peter D. Schiff in Money Morning.

“While this is billed as a benefit to homebuyers, it is just another handout to lenders, since the prospective buyers qualifying for the tax breaks will simply pay more at auctions as the tax breaks subsidize higher bids. The real winners are the creditors who will now get more in foreclosure than they would have had buyers not been counting on having their bids subsidized by the government.

“Of course, for all the talk about taxpayer bailouts, none of the Senators bothered to mention that — for the moment — no tax increases actually are on the table. Instead, the bailouts are being financed by savers, pensioners, wage earners, investors and the elderly on fixed incomes, who all suffer staggering increases in their costs of living, as the Fed uses inflation to rob Main Street to pay off Wall Street.”