Bailout Bounce

Make no mistake about it - Government can induce economic activity. What we must not do is link bailouts to economic recovery. An analogy to spending taxpayer's money to save taxpayers from themselves is inserting your fist into a pail of water. Whenever the fist is withdrawn, the water returns to its original level.

Another way of looking at it is the way we leverage our income with our credit cards. As long as we have an income to leverage, we make a lot of merchants happy. They, in turn, are able to leverage their receipts into more economic activity. The main reason that this works so well is because there are so many sources from the private sector, that should one fail, then activities from other sources compensate for the loss. But when there is only one source (such as the Government), and the funding from that source ends, everything upstream of the source fails. And, just like you and your credit card, the bill will come due. After all, when you leverage your paycheck, you are in actuality borrowing money.

Our banks found themselves over-leveraged using collateralized mortgage debt securities as an income stream. And when the value of the securities plummeted along with that income stream, the aftermath was a bag which contained debt out the whazoo with nothing to cover it. Those securities were real estate loans bundled into a device called a Collateralized Mortgage Obligation. Those CMO's lost their value because of bad lending practices to people without good credit standing. The same thing would happen to you if you lost your job and had to default on your debt. Bad loans meant defaults on payment for whatever reason by the borrowers.

Not wanting to digress into the cause of this financial mess, just wanting to illustrate what happens when the foundation of an economic system is lost. The same holds true for Government sponsored jobs and projects. Except for some relief in the short term, there has been no improvement to the situation. Remember the fist in the water. The Congress votes to spend a certain amount of money as a stimulus to the economy. Once they spend that money, then without more money, whatever depends on that money will cease. That includes the upstream economic activity developed supporting the project/work relief effort.

The temporary bounce received from the stimulus may not be beneficial in the longer run because of inflation. Inflation occurs when we dilute our money supply. Inflation is perhaps the cruelest tax of all. Think of the money supply as a bowl of soup. If you keep adding water to the soup without the other ingredients, you will find that the soup is so weak that nobody wants to eat/drink it. The Government is not collecting that stimulus money from the taxpayer (yet); there are only two sources available. It is either printed or borrowed from other countries. Either way creates a debt that will have to be paid -- just like your credit card debt when you lose your job. The money supply must stay in balance with goods and services to prevent inflation/deflation.

Be of good cheer though, Obama will straighten out everything.

Cheers,
Robert

Robert@robfg.com