The Future of America: A History

Just what will Barack Obama do to prove he really can fix the United States...?

CENTRAL BANKS lower interest rates to try to gin up some activity, writes Bill Bonner of The Daily Reckoning.

They set up another round of drinks, hoping the party will get going again. The Fed cut rates decisively (if a bit slowly) in the '30s. Japan's central bank went further – taking rates down to near-zero and leaving them at that level for years. The US Fed, meanwhile, has already hacked its key rate down to 1% here in 2008. It's ready to cut more...if need be.

But the central bankers are missing the point. They're like a liquor salesman at a meeting of Alcoholics Anonymous. Everyone is desperately trying to sober up – not go on another bender. Of course, the Feds will get a few people to take up the bottle again...but these poor saps will be even worse off.

In this type of correction, people need to correct the mistakes of the late bubble. That means getting balance sheets back in balance. And that means spending less and saving more.

Economists describe this problem as "pushing on a string"...or a "liquidity trap". The central bank can make more credit more readily available, but it can't force people to borrow. Wednesday's news headlines included one that went to the heart of the matter:

"Government to force banks to lend."

But the problem is not so much the banks; it's the economy itself. Banks would be happy to lend, if only they could be reasonably sure of getting their money back.

But in a crumbling economy...who knows? And this is the tough financial situation that President Obama will face in January '09.

While monetary policy won't do much good, fiscal policy might. At least, there's plenty of temptation in fiscal policy...so much that powerful, ambitious and/or corrupt politicians always find it irresistible.

The principle is simple. If businesses won't spend...and consumers won't spend...the government will do the spending. This is the idea made popular by John Maynard Keynes and known today as "Keynesian" economics.

"We are all Keynesians now," said Richard Nixon back in the '70s. (As we said, the idea was irresistible...) Keynesian spending doesn't really make people better off, but it has three things going for it:
It gives politicians an excuse to spend more money;
It looks like things are getting better. At least government is "doing something";
It tends to keep the lights on.

In the coming US downturn (we say "coming" because the worst of it is still in the future), consumers are likely to pull hard on their belts and send the rate of saving soaring. Maybe not the 20%-30% of incomes you see Japanese and Chinese households putting aside each year, but at least back to the 10% we saw before the 1990s.

That will remove more than $1 trillion from the economy, directly. Indirectly, it will remove a lot more. And here we bring bad tidings of Christmas.

"Balloon bursts on festive parties in tough times," is a headline at the Financial Times. Companies are cutting back sharply on their holiday celebrations. We know that from personal experience. A memo just received from corporate headquarters in Baltimore tells us that the annual Christmas party will be greatly scaled down. "Employees only," is the word. But the grinches in our own little company are generous compared to those in other firms.

The big Wall Street firms "have scrapped extravagant parties," comes the word from the street. "What's there to celebrate?" asked one executive. "It's the year from Hell." But that's just a "glass half empty" way of looking at it. This is in fact a correction. And in corrections, spending goes down as people correct the errors of the past.

In Detroit, GM and Chrysler have cancelled their big holiday bashes, too. Oh, the poor caterers! It's not as if there were a lot of upper-end work in Detroit these days. The caterers probably waited all year to put on a big do at Christmas for the carmakers. Then, Wham! They cut off the juice...the party lights go out...and it's a cold, cold winter in Detroit. As if it weren't cold enough already!

The automakers are trying to cut costs as rapidly as they can. But revenues fall faster. Vehicle sales fell again in October – for the 12th month running. This is the longest losing stretch in 17 years. A writer for Britain's Spectator Business took a drive to Detroit to check on the state of things. Spotting a live human being in a huge parking lot...apparently guarding an abandoned factory...he stopped to chat.

"Ten years ago, this place was booming," said the guard. "Hard to believe isn't it? Back in '85 I used to work for General Motors fitting radios and cruise-control switches to the dashboards of cars. But they moved the factory somewhere else and that was that. Now I do security. Although what they're guarding this for, I do not know. There's nothing here."

Behind him was the apocalyptic scene we associate with Detroit. Then, referring to the American Dream, the guard took up his reflection:

"I thought it was the auto industry...with jobs and pension and health insurance and what not, but that went pop. Now they say they are building condos everywhere down here, but I don't know who they think is going to buy them. I guess that's another type of dream."

"It's time to wake up, America," continues the reporter, "this dream has become a nightmare."

So, in addition to the $1 trillion taken out by the savers...there's also the effect of less spending magnified all through the economy. The caterer doesn't get to serve up a holiday party...the baker doesn't get to bake...the liquor bottles begin to collect dust...and from the guys who park cars to the babysitters to the hairdresser...the whole economy spins fewer dollars...people earn less...and they pay less tax. Then, at the far back of the income bus, the most marginal workers fall off altogether. The jobs they could get anytime before can't be gotten at all now. McDonald's begins to get choosey. It wants someone with a master's degree in fluid mechanics to man its deep-frying. And over at the Bright Nails shop, heck, they're looking for someone who used to be a chemist!

So the guys with few skills and spotty employment records can't get a job at all. So they should do like those fellows in Latin America and South Africa, standing out on the roadsides and waiting for anyone to pick them up and put them to work, a day at a time...one hour after the other.

They get paid at the end of the day – in cash. And they have to reduce the cost of their labor to the point where they're worth hiring, in other words.

But this is the United States of America we're talking about. This is a democracy. And there are a lot of votes in the greater Detroit area...and a lot of Democrats who are going to be really cheesed off if their man in the White House doesn't do something to protect the voters from reality.

So what's Obama going to do? Simple; he's going to do what his most persuasive advisors tell him to do...and he's going to borrow all those savings and put them to work. Everyone wants the safety of Treasury paper. Fortunately, the Obama Administration is going to give them plenty of it. They'll absorb the trillion or so in US savings...and then everything else they can get their hands on – including much of the rest of the world's savings, too.

The US deficit will soar – along with the national debt. Interest rates will rise. And then...maybe 18 months from now...maybe 10 years from now...it will get really interesting.