globoTRENDS blog (from Summit Global Education)

Many economists are now calling for the US to embark in a massive “shock therapy” fiscal stimulus package to bring the US economy back to life (and save us from a severe recession).  While I see their reasoning, and I appreciate their optimism, I am doubtful that the US has enough firepower or ability to slow this one down (on their own).  Its only with a well coordinated global action that a fiscal stimulus would work.

The financial and economic crises are too big and too global for any one (national) local fiscal stimulus package to have much effect.  If the US moves forward with plans to spend up to $700 billion in fiscal stimulus (building roads, bridges, and green investments), we may end up with many new roads and bridges, but its unlikely that this action alone will pull the US out of recession.

The government of the US can not spend nearly enough money to make a significant change in the over-powering deleveraging process that is working its way through the world of global finance.  Perhaps even a coordinated attempt by many governments would not be enough to jolt this train (wreck) back on track.

Over the past few weeks, there has been alot of discussion about an upcoming fiscal stimulus package.  President elect Obama has put much attention to this topic…then, yesterday, there was a lineup of Governors from across the US that came to Washington to pitch President elect Obama on the need for $176B in fiscal spending to jump start the economy. In addition, there is along line of industry leaders lining up with their hands out looking for help.

Conclusion:  the US is clearly considering a fiscal stimulus package as the way out of this mess…but Im not so sure that this conclusion is correct.

Lack of Monetarist options:

I agree with the conclusion that traditional monetary policy remedies will not work.  Not this time.  In GloboTrends, I have previously stated that Monetary policy wont work during this particular crisis (to jump start the US economy) because of the malfunctioning credit markets.  In this posting, Im going to cover why I believe that fiscal stimulus won’t work either, and why the US should not borrow vast amounts of money to do this.

Existing Fiscal stimulus has done nothing

First of all, I ask that readers consider the massive fiscal stimulus package that has already hit the consumers since July (2008)….What fiscal stimulus package you ask?   The stunning recent fall in gasoline prices globally, of course!  (this has been a MASSIVE economic stimulus package that has been launched globally, putting cash into consumers hands, and has boosted confidence, making people feel richer).

Falling gas prices = same as fiscal stimulus

This fall in gas prices must be one of the largest (and most welcome) fiscal stimulus package imaginable for struggling governments around the globe.  They got the fiscal boost without having to raise taxes or pass any new laws.   But the lesson of the gas-price fiscal stimulus is that people will save their money rather than spend it, and that consumers are less willing to spend new money than they have in the past.

While the gas-price fiscal stimulus may be small in comparison to the proposed $700bn bandied about by the new administration, its doubtful that the entire sum could be put to productive use immediately.  Instead, what we are looking at is a mixture of road building, green projects and tax cuts.  The infrastructure projects might put people to work, but the fiscal impact would be spread over months or even years.  The tax cuts would be more immediate, but the new money would probably be saved rather than spent (as is shown in the gas-price stimulus example).  In the rest of this posting, I will examine the size and impact of this gas-price fiscal stimulus….

But, if you consider that retail gasoline prices just in the US have fallen by more than half in the past 4 months, and if you consider that most families in the US have two cars that they were filling up twice per week, this is an immediate savings for the average American consumer of hundreds of dollars per week, every week.

The fiscal stimulus from falling gasoline prices:

In the following paragraphs, Im going to briefly estimate the (rough) fiscal stimulus generated just from the recent fall in gasoline prices…

On July 14th, 2008, the national average gasoline cost $4.054 in the USA.  As of December 1st, that average cost per gallon has fallen to just $1.79.   This is a savings of over $2.26 per gallon just since July. (see chart & source below)

Assuming the US uses approximately 400 million gallons per day (estimate from 2006), and if we assume an average savings of $1.125 per gallon (1/2 of the savings), then over the past 141 days (since July 14th) the US consumers would have saved $63,450 million USD.  If you ever heard that “a penny saved is a penny earned”, then you would agree that this is the financial equivalent of giving US consumers a (surprise) gift of an additional $63 billion to spend (for Christmas presents, holiday travel, whatever).

Put another way, we have ALREADY enjoyed a nice $63 billion dollar fiscal stimulus due to cheaper gas prices here in the USA (just over the past 4 months).    If you assume that the price of gasoline will stay at this same level for another 4 months, thats another $63 billion.  If gasoline prices fall even further, thats even more stimulus.

Then, think of the impact of this fiscal stimulus globally…

If you assume that the US consumes just 44% of the worldwide gasoline, then that would imply that there has been an additional global fiscal stimulus over the past 4 months of an additional $80.754 billion USD globally.   Add them up, and you see that we have recently enjoyed a nice $144.204 billion dollar fiscal stimulus globally over just the past 4 months.   Wow, that’s pretty impressive….roughly the size of the Philippines annual GDP.

But, what has been the impact of all this extra consumption power in the hands of consumers?  Not much.

The economy is sinking fast, and we are dreaming if we think that by spending on roads and bridges, green projects and tax breaks that we will somehow stimulate consumers to start spending enough to pull us through this mess. 

Timing and dispersion are both important

First of all, infrastructure-style fiscal stimulus, no matter how large, will take months or years to hit the real economy.  Planning on spending $700bn is not the same as actually spending $700bn today.

Second of all, tax breaks or gifts to consumers will not likely get spent in their entirety, as Americans are fearful of loosing jobs and are likely to save (just as American banks are saving the money they are receiving, rather than increasing lending).

So, in conclusion…

It is my belief that we have already enjoyed a massive (global) fiscal stimulus in the form of lower oil prices, but that has hardly translated into any meaningful economic bounce to our ailing global economy.  The trouble is that fiscal spending is not enough in this deleveraging environment, and if the US government embarks down this road, Im fearful it will be like throwing (borrowed) money into the fire (sure, it may make us feel warmer for a little while, but the spark wont last, and in the end, the fire will run its natural course).

Final thought:

At this moment in time, perhaps the US government should be encouraging the US consumers to start saving again, rather than seeking ways to encourage them to spend.  This might come in really handy if the US dollar were to lose value, and if foreigners decide to no longer fund the US consumers / business/ government.

source:  Energy Information Administration, Official Energy statistics from the US government

Further reading from GloboTrends:

• Fiscal Policy
• Monetary Policy
• Deleveraging