By Peter D. Schiff
In perhaps one of biggest ironies to ever to come out of Washington, Congress recently pilloried major league baseball players for using artificial stimulants to pump up their performance while at the same time passing legislation to do the very same thing to the U.S. economy.
Am I the only one laughing?
The reality is that the U.S. economy’s current slump is actually the fallout from years of financial doping that took the form of easy credit and skyrocketing housing prices. Instead of reaching for another syringe, Congress should ask Americans to do exactly what it demands of big-league ballplayers: Play within your means.
The Downside of “Getting Juiced”
Unfortunately, when it comes to the U.S. economy, there’s a big problem. The would-be patient is already so “juiced” on the afore-mentioned financial steroids that additional treatments will probably fail to achieve the desired stimulus. In fact, the treatment could result in a trip to the emergency room.
When the widely praised “economic stimulus” bill was signed into law earlier this month, the lone dissent came from those who thought the bill did not go far enough. Speaking for those unheard voices that disagreed with the strategy entirely, I can say that I believe the most significant aspect of the plan is that it creates a new and improved method for delivering inflation.
Previously, the government largely relied on interest-rate reductions to keep the economy humming. In this method, money supply growth, also known as inflation, is channeled through the banking system. The U.S. Federal Reserve first makes cheap credit available to banks, which then can either lend out the new funds, or use them to acquire higher-yielding assets. As a result, asset prices – such as stocks, bonds and real estate – have been bid up to bubble levels.
However, the inflationary impact on consumer prices occurs with a considerable lag.
Now that rate cuts alone are proving insufficient – mainly because banks are so overloaded with questionable collateral and shaky loans that few can consider acquiring more assets or extending additional credit [no matter how cheap such activities can be funded] – the federal government is opting for a more direct approach.
By printing money and mailing it directly to the citizenry, the “stimulus plan” cuts out all of the financial middlemen and administers the inflation drug directly to consumers.
If simply printing money could solve financial problems, the Fed could send $10 million to every citizen and we could all retire en masse to Barbados. However, more money chasing a given supply of goods simply pushes up prices and does nothing to improve the underlying economics of a problem-plagued market such as ours. And since this new money will go directly into consumer spending, without first being filtered through the asset markets, the effects [read that to mean damage] on consumer prices will be far more immediate.
No Pain, No Gain
This politically inspired placebo will do nothing to cure what ails our economy. The additional consumer spending will merely exacerbate our imbalances and allow the underlying problems to worsen. In the near term, it will put additional upward pressure on consumer prices and eventually will force up long-term interest rates.
The failure of the stimulus plan to cure the economy will cause the government, and the Wall Street brain trust, to conclude the injection was simply too small. Their next solution will be to administer an even stronger dose.
My prediction is that – over the course of the next few years – successive doses of even larger stimulus packages will fail to revive the economy. The recession will worsen, the dollar will drop through the floor, and consumer prices and long-term interest rates will shoot through the roof.
The result: Politicians and economists will look for scapegoats. But few, if any, of our elected leaders will properly attribute the problems to the toxic effects of the stimulus itself.
Like all drugs, the biggest danger is an overdose. In monetary terms, an overdose is hyperinflation, which surely will kill our economy. It is my sincere hope that before we reach that “point of no return,” one of our sharper and well-positioned economic diagnosticians will make a correct diagnosis – and that our elected officials and central bank leaders will listen.
When that occurs, the stimulants will be cut off, and the free market will finally be allowed to administer the only cure that works: A cleansing recession.
If that means that we have to lose some velocity on our fastball, so be it. Maybe we could use a few months in the minor leagues to get back to basics. Besides, there are always plenty of opportunities in the majors for a “crafty veteran” who can win with wile.
We may not like the economic side effects of stopping cold turkey. But rest assured, it surely beats having to cart our cash around in wheelbarrows – as they did in the Weimar Republic during the hyperinflation episode of the 1920s.
[Editor’s Note: Money Morning Guest Columnist Peter D. Schiff is the president of Euro Pacific Capital Inc., a Darien, Conn.-based broker/dealer known for its foreign-markets expertise. A well-known financial author and commentator, Schiff is a regular Money Morning contributor, and has most recently written about speculative bubbles, Wall Street’s lost dominance and soaring gold prices. In mid-August, when analysts were touting beaten-down financial shares, Schiff said the stocks were "toxic," were destined "to get hit hard," and advised investors to "stay away." Investors who heeded that advice, and avoided such shares as Merrill Lynch, also avoided some stressful, subprime-induced losses. Schiff’s first book, " ," was published by Wiley & Sons in February 2007. To order the book, please click here].
News and Related Story Links:
- Money Morning News:
Congress Passes $168 Billion Stimulus Package
- Money Morning Commentary:
Until the Fed Feeds Us More Salad and Fewer Twinkies, Speculative Bubbles Will Remain a Risk