Since the beginning of the current credit crisis in August 2007, the Fed has taken an aggressive stance toward easing monetary policy. The goal was to keep the banking system liquid and to reduce the risk of deflation. As the private sector reduced its leverage, the Federal Reserve has increased its own. The Federal Reserve has done this by greatly expanding its own balance sheet, effectively becoming one of the largest hedge funds in the world.
The Federal Reserve’s most aggressive move into the world of structured finance began full operation in late March. The TALF (Term Asset Backed Securities Loan Facility) enables the Fed to purchase up to $1 trillion in securitized debt, an unprecedented move that substantially increases the future risk of inflation. TALF purchases AAA-rated, asset-backed securities backed by newly and recently originated auto loans, credit card loans, student loans, and SBA-guaranteed small business loans.
Spend to the End
The Obama administration has been very aggressive in pushing through its spending proposals. Last year’s $188 billion stimulus package seems like a quaint notion in comparison to the massive $787 billion stimulus package passed in February. That package had a little something for everyone.
The stimulus package contained a mix of spending on jobless benefits ($83 billion), health care ($148 billion) and tax cuts for both individuals ($237 billion) and businesses ($51 billion), as well as spending on what is typically thought of as stimulus, like building roads ($45 billion) and energy infrastructure ($45 billion). At $787 billion, the total stimulus package is slightly more than 5 percent of total GDP. In addition to the stimulus package, the U.S. Congress has also passed an 8 percent increase in spending for the balance of fiscal year 2009.
With an aggressive fiscal and monetary policy in place in the United States, a case can be made for cautious optimism. The recession in the United States turned severe this past fall when credit markets contracted and consumer spending went into a cliff dive. The combination of credit contraction, wealth destruction and lost employment was simply too much for the world economy’s consumer of last resort. Not since President Carter slapped credit controls on the American consumer in the spring of 1980 have we seen consumer spending in such a free fall.
Credit markets have slowly healed. Measures of credit distress have ebbed. The U.S. Treasury yield curve, a measure that has the single best track record of any financial leading indicator, has steepened — a positive sign for future growth. In the household sector, cash flow is currently being hurt by the sharp contraction in employment. Offsetting those job declines has been a sharp rise in real hourly earnings. Falling prices for energy and other consumer staples have given a sharp boost to consumer purchasing power. Real disposable income has been up five months in a row through January for an annualized gain of 11 percent. Additional gains in cash flow are coming in the form of tax reduction for middle- and low-income consumers. Consumers have the means to spend more; they simply have been lacking the will.
Stabilization in consumer spending will halt the severe inventory reduction that has accelerated the economy’s downward slide. With inventories lean, any small pickup in spending will produce an increase in industrial production, making the recovery more self-reinforcing. Business investment will follow, and eventually more businesses will start to hire.
Conclusions and Observations
The business cycle is a little like a rubber band. The more it gets pushed down, the sharper the recovery. The conventional wisdom for the coming recovery is that it will be tepid at best. It’s argued that the consumer is hopelessly in debt and unable to spend while business investment is constrained by excess capacity. By the time it’s all over, the current recession will have been the worst downturn of the post-World War II era. As such, the economy is creating an unprecedented level of pent-up demand, particularly for durable goods.
With home prices falling, housing has become more affordable than at any time in recent memory. Weak auto sales have produced a sizable increase in fleet age. Both should produce sizable increases in consumer demand once the banking system is stabilized. The same is true for business investment. Stronger demand coupled with delayed investment will create a very favorable environment for stronger business investment. Couple this pent-up demand with unprecedented levels of fiscal and monetary stimulus, and this should make the recovery anything but conventional.
Source: Progressive Grocer
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