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.

Print Friendly, PDF & Email


  1. Mike


    Would you comment on whether a country that relies on “consumption” can truly “grow”?

    It just seems to me that we’ve wasted trillions of dollars propping up a false sense of prosperity over the past 30 years. Now, the bill is coming due. Any economy that relies on its citizens to “consume” their way to prosperity, cannot create meaningful wealth.

    I have not heard much discussion about this, but I imagine I will as this crisis becomes more acute, is that we have witnessed a COLOSSAL mis-allocation of capital and resources into the building of houses. Houses are an unproductive asset, especially at over-inflated prices. If this country is to pay off its debt, don’t we have to find a more productive means of generating capital?

    Thanks for all your hard work!


  2. Anonymous

    a bit of off-topic, but if the treasury using $700B of taxpayer’s money, does that mean that treasury is issuing $700B of t-bonds? and if so, does that mean that it is reducing liquidity from the market???


  3. ScottH

    Mike said:

    “I have not heard much discussion about this, but I imagine I will as this crisis becomes more acute, is that we have witnessed a COLOSSAL mis-allocation of capital and resources into the building of houses. Houses are an unproductive asset, especially at over-inflated prices. If this country is to pay off its debt, don’t we have to find a more productive means of generating capital?”
    Tell you one more thing that is massively overbuilt – the financial services industry. And $700 billion just isn’t going to fix that. It will only invite an even larger catastrophe down the road a bit. It will also open the door to demands for much larger bailouts, and soon.

    The jig is up.

  4. rww

    The false causality will trouble our politics for years to come.

    Housing was the only thing buffering the American consumer from the effects of ten years of declining wages. With the housing bubble gone, a contraction was inevitable.

    But that won’t be the lesson learned. The lesson, instead, will be we need to bail out the big boys with big money on their say-so.

  5. Matt Dubuque

    Matt Dubuque

    As previously stated, the risks are profoundly deflationary.

    As I have warned here for some time and online for months we face an absolute collapse in global demand caused by the absolute and total liquidation of the world’s financial system.

    Those who continue to rail against the dangers of imminent inflation only increase the risk of a global depression.

    But that is likely unavoidable anyway, bailout or not.

    The writing of history goes to the victors.

    Matthew Dubuque

  6. Anonymous

    One problem that the US did not have during the great depression was a shortage of crude oil. In fact, the US would become the worlds largest exporter of crude for a time.

    Now the situation is quite different and any discussion of a US economic recovery must include the fact that the US imports 2/3 of the crude that it uses.

    One aspect of the huge demand for foreign crude in the US: if Bernanke decides to attempt to monetize the debt (and I doubt he can pull it off) then oil in dollars will rise accordingly.

    If oil prices rise dramatically in dollars I expect that oil will be denominated in some other currency or basket of curriencies…Then the US will be in for a very difficult if not impossible economic recovery effort.


  7. Lewis B. Sckolnick

    And what is the plan AFTER the 700B.

    We need to get our banks out of the fee business. If we do I think we would see a lot more liquidity very soon.

Comments are closed.