Tim Duy: Economy Downshifting, Bailout or No

Tim Duy at Economist’s View tells us that the economy is slowing down markedly, and that that will lead to a lot of false causality. Whether the bailout plan gets done in some reasonable form or not, the slowdown will be blamed on its failure, or the fact that the rush to get it done meant an ineffective program was put in place.

Duy also addresses one of our pet issues: a slowdown is inevitable because US consumption has been at an unsustainable level. Lowering consumption will reduce growth, and with the economy at barely above a stall, any further reduction means recession. But in America, recessions are not supposed to be inevitable. Permanent growth is our God-given right. But it looks like we have fallen out of divine favor of late.

From Economist’s View:

The US economy is limping through the second half of the year as the impact of this summer’s stimulus checks fades. The continued weakness, I suspect, will come as a shock to the public, who have now been essentially promised that their problems will be solved with a bailout package they really don’t understand to begin with for the financial sector they view as arrogant aggregators of wealth. But any bailout will only prevent a financial meltdown that threatens to deepen the credit crunch and worsen the ongoing slowdown, not reverse the current weakness. I doubt, however, the general public sees that distinction. And they are not likely to be convinced; this Administration sacrificed its credibility long ago. Instead, the public will see billions channeled into Wall Street as the unemployment rate climbs. And climb it will.

The flow of data this week, for those paying attention, is decidedly negative in tone. The housing market continues to deteriorate, with a precipitous decline in new home sales reported today. By definition, we must be closer to a bottom on new construction – but, to say the least, that bottom remains elusive. Initial unemployment claims, reached nearly 500,000 last week, although the Department of Labor attributes roughly 50k to the impact of recent hurricanes. Still, initial claims hovering around 450k foreshadows another weak employment report next week. Perhaps the most discouraging report this week was the advance durable goods release, which revealed a 2% decline in new orders for nondefence, nonaircraft capital goods. As Spencer at Angry Bear notes, the report is a negative for third quarter GDP….

To compensate for reduced access to capital markets, policymakers initiated a fiscal stimulus package to put cash in the hands of households. The debt necessary to support the package was floated onto financial markets and absorbed by foreign central banks. Households traded one debt-financed cash infusion for another. Because, as should have been expected, housing markets did not recover over the summer, the government stimulus provided only temporary relief. Households need a steady source of cash beyond their incomes to support their consumptive proclivities; without some artificial support, consumer spending will contract as a percentage of overall economic activity. I tend to believe this process is inexorable. Economic growth needs to become less dependent on consumer spending to be sustainable in the long run. Policymakers can cushion the blow, but policy should avoid entirely resisting the adjustment….

My hope is that a bailout is coming. But it will not change the path the economy is already on, it will only prevent activity from shifting to a new, less desirable path. I don’t quite see how the billions of dollars plowed into this program will be funneled to households. I see instead it will only cushion the process of deleveraging, and thus minimize the quantity of resources stripped from the economy. This is important and necessary, but will not provide a miracle cure for the economy’s travails….

How will the bailout and fiscal stimulus be financed? If it is not deficit spending, it will not be stimulative. My preference is for policy to focus on restructuring, not stimulus. Accept that we cannot deficit spend out way to prosperity, and support the bailout and additional stimulus via a tax increase on top income earners, those who have benefited most from Wall Street’s orgy of debt. I recognize, however, that it would be silly of me to actually expect that Americans would stand for self-financing their problems, and instead foreign central banks will be called upon to finance the bailout and future stimulus.

The entire post is very much worth reading.