Normally, investors will have different preferences with respect to risk and return, and in this manner the funds are allocated efficiently across borrowers. But times are anything but normal. Due to the extreme economic turbulence, investors’ appetite for risk has vanished. Everyone wants to hold the safest investment – U.S. debt.
Our current economic woes are defined by this devastating credit crunch. Banks and businesses large and small are having a difficult time funding their operations. The government’s grand plans to jumpstart the economy include bailing out major corporations (such as the auto industry), the banking sector, as well as state and local governments, thereby alleviating the credit crunch. This is where the futility of the government’s borrowings comes full circle.
When the U.S. government raises money, by definition, these activities precludes private companies from raising the same money – investors can only allocate their dollars once. Therefore, by increasing the government debt the government is making it more difficult for companies (and state and local governments) to issue debt to fund their operations. Therefore, every dollar the government spends as part of its gigantic stimulus program has, and must continue, to be diverted away from other potential borrowers (such as private companies).
Had the government not increased its debt a greater amount of resources would have been available for investment in the private sector – the same private sector companies that the government is now “bailing out” because they are not able to raise enough money. Importantly, the judgment of millions of investors would have been deciding which companies should be receiving the funds.
Instead, the government decided to go on a spending binge, and flood the market with increased government debt, worsening the very credit crisis the government’s actions were supposed to be alleviating. Additionally, the political process is now deciding which companies should receive the scarce funds. Political heavyweights such as the automobile manufacturers are now receiving the funds at the expense of other more productive sectors.
The spending spree and de facto nationalizations of key industries will significantly increase our national debt; worsen the U.S. economic fundamentals; and, leave the U.S. economy with another terrible hangover. Worse, these actions push us further down that slippery slope toward a socialized economy.
While it is too late to avoid another hangover, it is not too late to minimize the pain. Instead of spending the $850 billion stimulus in haste, the new Administration and Congress should sit back and rethink its approach to revitalizing our economy. Otherwise, as Herodotus would counsel, our haste will end in failure.