Every Economic Stimulus Should Be Matched With an Economic Deterrent

Battelle Medical face masks coronavirus economic stimulusmohamed_hassan / Pixabay

The coronavirus crisis has done great damage to our economy and threatens to do more. Policymakers quickly took up consideration of a number of economic stimulus measures. That makes sense. An economic downturn can turn into a spiral of negativity. Breaking the downward spiraling is imperative.

But….

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Earning Economic growth

ultimately must be earned. When a stimulus works, it works by taking growth that otherwise would have appeared in the future and speeding it up, letting us enjoy it at a time when we are more in need of it.

There was a time when providing an economic stimulus was viewed as a bad thing. The thought was that policymakers should keep their hands off the economy and let the economic system work things out for itself. That laissez-faire approach went out of favor when the Great Depression made it appear for a time that the economic system no longer was able to work things out by itself and could only get restarted with a push from the outside. A good case can be made that the successful working of our economy is too important to the lives of too many of us for it to be realistic today for us not to get involved in fixing it when it is broken.

But I think that it is important that we understand that no stimulus comes without a price. A stimulus moves assets and profits from places where they would have landed naturally to new places. So there is always a negative attached to the positive. If the purpose of the stimulus is to shift growth to a time when it is more urgently needed -- this is the case with the coronavirus stimulus proposals -- growth is being reduced at some future time.

We should acknowledge that and choose the time from which the assets and profits are being taken rather than letting the economic system do it for us. The entire idea of providing a stimulus is to exert some power over the economy. If we are not clear about how the price for the stimulus is being paid, we are deliberately avoiding taking on such power because we do not want to acknowledge that every stimulus comes at a price.

A Black Swan Event

Some have described the coronavirus as a black swan event. It is certainly a highly unusual event and one that was not anticipated by hardly anyone. So there is a sense in which the term fits. But I worry that we refer to this development as a “black swan” event as a means of escaping responsibility for having engaged in behavior that made it worse.

The 2008 crash was said to have been caused by problems with the financing of mortgages and that series of developments too was said to have constituted a “black swan.” There is a sense, of course, in which every price crash is a black swan event. Had most of us known the crash was coming, we would have taken money out of the market and the price crash would have arrived at an earlier time. By definition a crash has to come as a shock.

But both the 2008 crash and the 2020 crash are similar in one very important way. Both began at times of insanely high CAPE values. All crashes of lasting significance do. So it could be said that black swans become predictable when stock prices rise to unsustainable levels. The particulars cannot be known in advance. But when we reach the price levels that applied prior to the 2008 crash and the 2020 crash, we know that in not too long a time we will be seeing some terrible economic development that will send prices falling hard.

Applying An Economic Stimulus

We employed an economic stimulus to recover from the 2008 crash. That was a good thing. I recall being horrified when an article appeared in the Wall Street Journal stating that we might be heading into a Second Great Depression. In such circumstances, a stimulus is certainly in order.

But it disappointed me when the CAPE level, which had dropped from the high 20s to 13 in the days following the 2008 crash, rose back to the high 20s in not too long a time after the economic stimulus was applied. Yes, we got the economy out of a bad place and that was to be celebrated. But, by letting stock prices rise again to dangerously high levels, we insured that things would be turning bad again in not too long a time. And here we are.

Economic Stimulus: Conclusion

High stock prices put more money in our pockets. That’s the appeal. But they also signal a hard price drop up ahead, one that will do serious damage to our entire economic system. I wish that the Federal Reserve would have taken action after saving the economy to deliver a bit of a hit to it when it would have been better able to take the blow and thereby to get stock prices down to more reasonable levels. That would have made for a less exciting economic recovery but one likely to last longer.

An economic stimulus must be paid for. If we are going to take economic growth from the future and place it in the present, when it is more urgently needed, we must remember to set economic growth back a bit after the sense of urgency has passed so that we will be able to enjoy those good economic times for some years to come. As my Buy-and-Hold friends often observe, there is no such thing as a free lunch.

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About the Author

robbennett
Rob Bennett’s A Rich Life blog aims to put the “personal” back into “personal finance” - he focuses on the role played by emotion in saving and investing decisions. Rob developed the Passion Saving approach to money management; Passion Savers save not to finance their old-age retirements but to enjoy more freedom and opportunity in their 20s, 30s, 40s, and 50s - because they pursue saving goals over which they feel a more intense personal concern, they are more motivated to save effectively. He also developed the Valuation-Informed Indexing investing strategy, a strategy that combines the most powerful insights of Vanguard Founder John Bogle and Yale Professsor Robert Shiller in a simple approach offering higher returns at greatly diminished risk. Tom Gardner, co-founder of the Motley Fool web site, said of Rob’s work: “The elegant simplicty of his ideas warms the heart and startles the brain.”

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