by James A. Bacon
Cackling with joy now that the Gross Domestic Product is projected to grow 2.4% this year, lovers of the leviathan state see the faster pace of recovery as a vindication of the Obama administration’s activist economic policies. In truth, the current burst of growth reflects the most stimulative fiscal policy since World War II combined with one of the most stimulative monetary policies ever.
The question that leaps immediately to mind is, “How long can it last?” The answer: “Not long.”
The chart below shows the yield on 10-year Treasuries adjusted for inflation — the “real” interest rate.
The rate was low — dangerously low — during the Bush years, and it is widely acknowledged that Federal Reserve Board policy under Chairman Alan Greenspan contributed to the real estate asset bubble and ensuing crash. But the low interest rates of the Bush/Greenspan era were nothing compared to the super-low rates engineered by Ben Bernanke. Real interest rates on Treasuries are now in negative territory. You can’t get any more stimulative than that.
Meanwhile, the Obama administration continues to rack up budget deficits, which, as a percentage of the economy, have no peace-time parallel in modern U.S. history. Keynesian stimulus during Obama’s years in office totals $5 trillion so far.
Both fiscal and monetary policies are unsustainable. The Obama administration sees deficits declining to less than $600 billion yearly later in the decade — a fiscal contraction of $700 billion in a $15 trillion-a-year economy. Republicans would like to cut even more aggressively. Failure to deliver on those deficit cuts would bring a brief reprieve in fiscal stimulus, but bigger deficits would propel Uncle Sam even more rapidly toward the Boomergeddon scenario I have written about.
Likewise, Fed policy is not sustainable. Bernanke thinks he can keep interest rates super-low for three years, but that’s only assuming inflation remains tame. If inflation heats up — it’s brushing against 3% right now — bond holders will revolt and demand higher yields to compensate for the eroding value of the dollar, accelerating the nation’s inevitable borrowing crisis. If inflation remains restrained, it will be for one reason only: Pallid economic growth keeps wages and commodity prices depressed.
The fact that one of the most stimulative economic policies in the history of the U.S. is yielding a growth rate around a measly 2.4% should be frightening. We’re using up all of our ammo. If the growth rate slows, we’ve got nothing left. We cannot increase fiscal stimulus to $2 trillion a year with collapsing the confidence of the capital markets. And when nominal interest rates are scraping zero, it’s hard to drive them any lower without igniting inflation.
Current policy may succeed in preserving the illusion of recovery long enough to re-elect Obama in November. But there will be economic hell to pay for the next president, whether it’s Obama or one of the tin men campaigning for the Republican nomination, when the inevitable slowdown comes.
It’s no wonder that businesses are hanging on to cash and bullet-proofing their balance sheets. Individual households should be doing the same, and so should Virginia’s state government.
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