Sunday, January 4, 2009

In at the deep end with a leaky bucket

It is estimated that the ecomonic stimulus packages announced by governments around the world will require the raising of some €2 trillion to fund them. This will require governments selling bonds to raise the money. The FT reports that this may put a squeeze on developing countries looking to raise money.

A second consequence is that this huge increase in the demand for money will cause the price of money (i.e. interest rates) to go up. If countries want to get money from lenders they will have to offer higher interest rates. This is at the same time that countries through their central banks are trying to get interest rates down.

At present interest rates on bonds are low as those with money are involved in the "flight to safety". Over time though this money will dry up and it is also possible that doubts about the ability of some countries to repay may force the rates up.

Essentially all these stimulus packages are doing is moving money from one part of the economy to the other - there is no net gain. In fact there may be a net loss. As one commentator notes:

The money has to come from somewhere. If you raise taxes to fund the plan, the people who are taxed are poorer and they'll spend less. If you borrow money to fund the plan, the people who buy the government bonds have less money to spend and that offsets the stimulus. It's like taking a bucket of water from the deep end of a pool and dumping it into the shallow end. Funny thing—the water in the shallow end doesn't get any deeper.

And it's likely the bucket is a bit like this:

Before government can inject money/spending into the economy, it first must take money out of the economy (borrow or tax), so the net result can never be anything more than a redistribution, shifting and transfer of income/spending from one group to another. Kind of like transferring water from Group A to Group B, but with a leaky bucket.

That's why stimulus schemes based on giving people money have a poor track record of energizing the economy. Usually, the only thing that gets stimulated is a politician's approval rating.

Back in October of last year the House of Representatives in the US voted on the "Bailout Bill" for the subprime crisis. The Bill was rejected. Five days later, they voted again. This time the bill was passed. What caused the change in the result? Here are some of the additions that were made to the bill.

Subtitle A--Renewable Energy Incentives

  • Sec. 101. Renewable energy credit.
  • Sec. 102. Production credit for electricity produced from marine renewables.
  • Sec. 103. Energy credit.
  • Sec. 104. Energy credit for small wind property.
  • Sec. 105. Energy credit for geothermal heat pump systems.
  • Sec. 106. Credit for residential energy efficient property.
  • Sec. 107. New clean renewable energy bonds.
  • Sec. 108. Credit for steel industry fuel.
  • Sec. 109. Special rule to implement FERC and State electric restructuring policy.

Subtitle B--Carbon Mitigation and Coal Provisions

  • Sec. 111. Expansion and modification of advanced coal project investment credit.
  • Sec. 112. Expansion and modification of coal gasification investment credit.
  • Sec. 113. Temporary increase in coal excise tax; funding of Black Lung Disability Trust Fund.
  • Sec. 114. Special rules for refund of the coal excise tax to certain coal producers and exporters.
  • Sec. 115. Tax credit for carbon dioxide sequestration.
  • Sec. 116. Certain income and gains relating to industrial source carbon dioxide treated as qualifying income for publicly traded partnerships.
  • Sec. 117. Carbon audit of the tax code.

Many of these provisions extend existing tax or investment credits for several more years. None of these provisions is directly relevant to confidence in credit markets. Why are they here? It's what happens when you let people spend other people's money. Here's one more and this one wins the "Too Absurd To Believe" prize:

  • Division C, SEC. 503. Exemption from excise tax for certain wooden arrows designed for use by children.

I kid you not! All of these countries are engaged in economic stimulation. All they are doing is moving money around - it has to come from somewhere. And when they get it they spend it in ways that please them.

For example, the Irish government has announced a multi-billion recapitalisation plan for the banks. Included in the plan is the provision that each bank use €100 million of the funds to be made available for "green projects" - it looks like our buckets are leaking too!

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