The markets took great comfort in Ben Bernanke's testimony to congress yesterday, reading it as a statement that the economy could recover by the end of the year. However, his statement was in the subjunctive mood, not the indicative; it was a conditional statement: IF all the bailout plans work by the end of the year, THEN the economy will recover. Well, duh. But as well-intentioned as the bailout plans are, there is good reason to believe that we are nowhere near the bottom. Further, all the plans do--if they do anything at all--is restore the pre-crash economy. But that economy was not viable; it was a house of cards to begin with, and restoring it will not place the economy in a secure position.
For example, a large portion of the capital of the banks is tied up in mortage obligations and, more importantly, "derivatives" based on those mortgages. But the housing values are nowhere near their bottom, if historical averages can be trusted.
If housing prices correct to their historical averages, which is likely, then the banks balance sheets will weaken and there will be a lot more "troubled assests" for the Troubled Assets Relief Program (TARP) to buy.
The President also laid out his plans last night. It is certainly a comprehensive and well-meaning plan, but I doubt that it will work. The problem with the plan is that it fails to recognize the structural problems in the economy. Obama hopes to restore American manufacturing through a heavy investment in "green" technologies. But even if this was successful, there is no reason to think that manufacturing of these new products won't be outsourced. This is the Tennessee Earnie Ford solution: in the end, we will be "another day older and deeper in debt," but we will not have accomplished anything.
A nation can only grow prosperous by making things. It can never grow properouse by speculation. Our economy is built not on real assets, but on speculative bets. But in speculation, for every winner there is a loser; one party's gains are precisely measured by another party's losses. Only making things can make the nation wealthy, only in the farms, fields, forests, fisheries, factories, and mines can we find our future. Bailing out the old economy will at best give us the old economy. At worst--and more likely--it will bankrupt us.
So what should the President be doing? There are many things he could do, but there are at least four things he ought to do over the course of the next four years:
- Devalue the dollar. The worth of money relative to other currencies should reflect their trade balances. A country like the United States, with a constant trade imbalance should have a constantly "shrinking" dollar, which by itself is sufficient to bring trade back into balance. But we have the worst of both worlds: a strong dollar and a trade deficit. Devaluing the dollar over the next four years will make imports more expensive and exports cheaper.
- Devaluing the dollar will make lenders more reluctant to lend. But this is not bad news, it is good news. Instead of borrowing the money for infrastructure improvements, we should just print it. While this seems radical, the fact is that we borrow it from people who just print it up themselves: the banks and the Chinese. The idea of "printing" money conjures up visions of hyperinflation. And if the money is just printed to finance tax cuts and operating expenses, this is a possibility. But if it is used to finance actual improvements, like roads, education, and the like, there need be no monetary inflation, so long as there are unemployed resources in the economy. In other words, we can invest our own money in our own future, and provide both jobs and real improvements along the way.
- Finance the highways through weight and distance based tolls. Right now, the "free" ways constitute a subsidy to long distance shippers and the globalized economy. But if the shippers had to pay the full cost of transporting their products, local and regional manufacturing would suddenly have a great advantage over foreign producers, no matter how little they pay their workers.
- Buy up and break up the institutions that claim to be "too big to fail" (see Buy it Up! Break it Up!.)