Oh, No, the Fed is Expected to Discuss More Ways to Revive the Economy!

The New York Times contains the headlines, “Fed is Expected to Discuss More Ways to Revive Economy.” (See http://www.nytimes.com/2010/09/20/business/economy/20fed.html?ref=todayspaper.) The Fed is mulling over ideas about how it can provide more stimulus to the economy to get more “oomph” into the economic recovery.

Chairman Ben, at the Fed’s conference held in Jackson Hole, Wyoming in August, said that the Fed was prepared to “take additional action” to protect the economy from falling into a period of deflation.

My question is “why do we need more Fed stimulus”?

Let me talk about the long term. I know, Americans don’t like to talk about the long term. And, we have an election in six weeks and Americans are in the middle of a debate about tax cuts and spending plans and arguments about how we can get the economy going again. After all, Americans want something done within two years or less! (See my post “What Should the Fed do next,” http://seekingalpha.com/article/224423-what-should-the-fed-and-the-federal-government-do-next.)

Let’s talk about the longer term anyway.

Since, 1960 Real Gross Domestic Product has grown in the United States at a compound rate of growth of 3.14% through 2009. (It grew at a 3.34% compound rate through 2007, the peak of the most recent cycle.)

This compound rate of growth is consistent with what economists have felt that the economy could grow at over the longer term. In the 1960s, the expected long term rate of growth of the economy was put at 3.20%.

My question is, could the economy have grown any faster over this time period? If you would have told an economist in the 1960s that the economy would grow at a compound rate of growth of about 3.2% over the next fifty years, would he or she have taken that growth rate and “put it in the bank”?

Could it be, unless a government creates hyperinflation or serious deflation, that governmental economic policies have very little effect over long term economic growth although it can have significant impacts on underemployment, the utilization of physical capital, and income distribution?

Yet during this time period the politicians (and many economists) have continually put pressure on the government to push for greater economic growth, first cyclically, but then also in a secular way. And yet, decade after decade the compound growth rate of the economy has remained, roughly, in the 3.2% range.

The continued pressure to “goose up economic growth” through fiscal stimulus has resulted in a continued rise in the gross federal debt of the government. The compound rate of growth of the federal debt is just under 8.0% for the 1960-2009 period of time.

This pressure on the economy has resulted in a secular climb in prices over this same period of time of slightly more than 4.0%. As I have argued before, this was a perfect environment for financial innovation and massive debt-leveraging, exactly what we saw.

This economic environment resulted in businesses, state and local governments, and families accumulating excessive amounts of debt.

This fiscal pressure to keep unemployment low kept many businesses in the same “legacy” physical plant and equipment being utilized so that the businesses could put workers back-to-work in their old jobs. As a consequence, the capacity utilization of industry continued to fall from peak-to-peak throughout the last fifty years. Maybe, just maybe, some of this physical capital should have been allowed to leave the scene.

And, in terms of labor, since the government tried to keep unemployment low by forcing the economy to hire people back into their old jobs, maybe, just maybe, a class of people became less employable in the general economy. Under-employment grew constantly over the past fifty years and now about one out of every four people of working age are either unemployed or underemployed.

Furthermore, recent research indicates there has been a serious skewing of the income distribution in the United States. Maybe, just maybe, continuous efforts to stimulate the economy through the government's fiscal policies to keep unemployment low among those that are less educated or are blue-collar workers and keep them in their "legacy" jobs puts these people at a significant disadvantage in the modern economy. If this happens then the income distribution in the economy can become more and more unbalances over time.

Maybe, just maybe, the American economy needs to re-adjust, to get itself up-to-speed in the modern world. It seems as if every week, someone else is measuring that the United States as less-and-less competitive relative to other up-and-coming nations. Could it be that the economic policies of the government created this environment?

Maybe, just maybe, American businesses and families and state and local governments need to
reduce their debt load.

Maybe, just maybe, American businesses need to modernize and up-grade their physical capital.

Maybe, just maybe, some in the American workforce need time to become employable again. (However, because of the above, some workers may never be employable again: http://www.nytimes.com/2010/09/20/business/economy/20older.html?hp.)

Forcing stimulus on the United States economy can stale the economy from restructuring and may keep people and businesses and governments from making the incremental changes they need to make in order to stay current. And, incremental adjustments are not so hurtful, so costly, and so time-consuming, as the discrete jumps in the economy that come about after things have been “forced” to stay as they were for such a long time.

Maybe, just maybe, the Fed needs to allow events to progress in a natural way. The Fed has provided the banking system with $1.0 trillion in excess reserves. The FDIC is working out “problem banks” in an orderly fashion. (Another six banks were closed last Friday helping to maintain an average of 3.4 bank closing per week this year.) It is expected that bank closings will continue at a very rapid pace well into 2011. Maybe, just maybe, this is all the economy needs at this time.

More action on the part of the Fed may only create even more problems in the future. Maybe, just maybe, the Fed needs to avoid any sign of panic at this time.