The Recession and Pushing on a String


Richard W. Crockett


There is much consensus that we are in a recession, but there are few ideas about how to get out of it, other than to simply wait it out, and that is not a good idea.  The lack of certainty that we are in one will last only until we have compiled data for two consecutive quarters on economic growth and if it is negative, we will then know.  The Federal Reserve has a plan to fight recession that involves driving down interest rates in order to ease credit markets in the hopes that banks will regain their courage and allow borrowers who need money to borrow and then presumably spend.  This is a kind of trickle down approach.  The cost of money goes down for banks and other lenders, and it is hopefully passed on to borrowers who can then afford to finance purchases. These purchases tend to stimulate the economy, again hopefully, out of recession.  There is always a cost to this strategy when done with a vengeance, as the Fed seems to be doing.  The cost is a cheapening of the dollar in foreign exchange, and this means that we in the United States will have to pay more for imported goods. The dollar could even lose it status as the “working” currency in world markets, which could create new and greater problems, which are beyond the scope of this discussion. As it is, things could start to look more expensive at Wal-Mart and other retail stores who traffic in imported goods. This cheapening of the dollar comes not from interest rates per se, but the increase in the money supply that this policy produces.  According to market theory, if there is more of a thing, even in the case of dollars, it has less value because its abundance tends toward a saturating of demand. In short the policy is inflationary.  This is apt to hurt the pocketbooks of persons on fixed incomes such as retirees.  Persons who have little or no discretionary income will feel this because wages are not likely to go up in a recession.  The injury seems to get to the little people first, but the benefits seem to get to them last.


Part of the Fed’s motivation in lowering interest rates is the housing crunch, especially in “sub-prime” mortgages.  For the last few years as jobs have gone overseas, the American consumer has substituted equity for income.  If we are not earning enough in our new lower paying jobs, following a plant closure, simply tap into home equity.  So we refinance our home at a teaser rate, sign the adjustable rate mortgage and voila, we have money to meet expenses with.  But this is a strategy that is bound to run out of gas. Many people are “max’d out” in their mortgages, and while housing construction has been one engine of growth, in the absence of manufacturing, it has created a glut in the national housing market and eventually contributed to a decline in real estate values.  Now borrowers are “upside down” in their mortgages.  This means that they owe more than the mortgaged property is worth.  Large institutions the size of a Wells Fargo or a Bank of America have banks around most of the country, and this “nationalization” of banking tends to nationalize banking skittishness about the mortgage business.  All feel it, even though the local market may be OK.  The Fed’s aim at lowering interest rates is to help the borrower with an adjustable rate mortgage, among other things.  But paradoxically, sometimes it hurts.  Some mortgages are tied to short-term securities, which actually rise when the Fed lowers rates.


While the Federal Reserve was created precisely to do what it is doing, that is to manage trends in the economy at the national level, it is more effective at slowing down an over-heated economy than stimulating a sluggish one.  The most descriptive metaphor that I know of to illustrate this idea is that of “pushing on a string.”  One may be able to pull an object with a string, but it is impossible to push an object with a string.  That is the essence Fed policy in the present instance and of supply-side theory. Pushing on a string.  What is the alternative?  The answer lies in choosing sides in an old argument between economic “liberals” and economic “conservatives” or at least between points of view which have been, correctly or incorrectly, labeled that way. 


The answer lies in budgetary fiscal policy.  Now plug your ears and close your eyes before you peek because this is going to be painful.  We need to stimulate the economy by (ouch) governmental spending on domestic programs and infrastructure. This is inflationary, too, but the virtue of it is that it is targeted.  This will mean running deficits for a time.  Now you may say, “For crying out loud, we are already running deficits, you idiot!”  True enough, but for the wrong purposes.  What we are blowing money on seems to have very little domestic multiplier or in other words, very little domestic economic effect. I am talking especially about the war in Iraq. And since we have shipped our manufacturing capacity to China and other Third World countries, it is more difficult to “prime the pump” through the stimulation of manufacturing.  We need to resort to those things that are purely domestic, if such things can be found.  There are some, though, and we need to notice what they are. A substantial public works program in the fashion of Roosevelt’s New Deal won’t do it by itself, but it will help, and we need the infrastructure repair.  This kind of expenditure is in a very high percentage spent with domestic contractors.  A health care program that eliminates the uninsured status of an additional 47,500,000 people would help.  That is domestic spending, and it is long term and sustaining, not merely a short-term fix the effect of which will quickly dissipate. We could also put some money into education, including incentives to attract the smartest people into the teaching profession.  They all don’t need to be medical doctors, astronauts or corporate CEO’s. This investment in the country’s future will pay dividends.  We also could through governmental funding help the development of “green” projects, including “greener” modes of transportation and shipping. How about testing and developing train locomotive style engineering on highway trucks, which pulling 80,000 pounds now make about 3 miles per gallon, making them primarily electric and using diesel only to generate electricity and run the electric motor, cutting back on the amount of diesel used significantly. This is a different design than a conventional “hybrid” vehicle.  Do you think this could have an impact upon the price of fuel, diesel in particular, which is currently over $4.25 per gallon in some instances? It could also impact the price of heating oil and gasoline. At this price it costs more than a thousand dollars to refill the tanks on an eighteen-wheeler.  Further, any funding of research and manufacture of green projects should include the requirement that they be manufactured and produced here.


There is some additional government employment which could help, such as adding to the ranks of the INS and border patrol, not for the purpose of badgering Mexican immigrants, but for securing and regulating the flow across the border so that we know who is here. We also need a serious upgrade in INS and other governmental technology.   The point is that these are domestic jobs and domestic expenditures.  While this is government activity, it is now necessary to do this since we have allowed the private sector to desert us by removing a major engine of the economy to overseas, the manufacturing sector of the economy.  These guys (the private sector) are not going to bail us out.  We need to do it ourselves, and by that I mean our “collective selves.”  To steal from Ben Franklin and put it in economic terms, through governmental endeavor, we need to “hang together” or through and excess of individualism, “we will hang separately.”