Between Scylla and Charybdis

Armstrong Williams
Wednesday, April 15, 2009

Legend has it that on their epic voyage back home to Ithica from Troy, King Odysseus and his crew had to pass through the deadly Strait of Messina. On one side, the monster Scylla threatened to eat any sailor who passed too closely. And on the other, Charybdis’ gaping maw threatened to swallow Odysseus’s ship whole. The Obama Administration faces a similar difficulty in navigating the U.S. economy through the current crisis aboard Congress’s nearly $1 trillion (and possibly more) economic recovery flotilla.

The ‘stimulus plan’ as it is more commonly known, is cast as a tool of fiscal policy in which the government temporarily increases its consumption of goods and services --- in this case civil infrastructure improvements --- in order to stabilize demand in the short term, thus enabling firms to keep employing workers that they would otherwise have to lay off. The administration (and most of America) hopes that this massive spending will stave off further decline while the private sector retools and banks have managed to sell off their euphemistically monickered “toxic assets” (to the Government) and start lending again.

While this sounds good in theory, an inherent danger that the government’s temporary programs will end up becoming permanent. Social programs designed to ease pain in the short term might ultimately morph into gargantu an entitlements, the likes of which have not been implemented since the New Deal, when many of today’s grand entitlements, including the now almost bankrupt social security system, were promulgated. Everyone in Washington knows that news of new government spending plan tends to act as chum in the water for predatory private interests, who then employ scores of lobbyists whose very business it is to stay in business by keeping the money flowing.

Those who know how Washington works fear that, under the guise of saving the nation from an economic Scylla, the government will go from being the consumer of last resort to the only customer in town. President Obama’s chief of staff Rahm Emanuel signaled as much last November when he uttered the ominous phrase, “you never want to let a serious crisis go to waste. And by that I mean to do things you think you could not do before.”

If the stimulus package provides any indication of things to come, the current administration intends to greatly expand government-funded health insurance programs, something that the Democrats in Congress probably know they could not do under normal economic conditions. Provisions in the stimulus plan include state-funded medical benefits for the unemployed, signaling a conceptual shift in how the government will ultimately tax businesses for social benefits.

If this supposedly temporary extension of unemployment insurance under the stimulus plan signals the administration’s intention to implement a ‘single payer’ medical system proposed, it could end up having deflationary, rather than stimulating effects on the private sector – thus prolonging the need for government intervention and further deflating the economy. While ensuring that every American has access to ‘affordable’ health care may seem noble in theory, in practice it could end up having devastating effects on the economy. In particular, government-regulated care is likely to have anti-competitive effects on private industry, particularly in the areas of pharmaceutical development and acute care. Moreover, the Government will likely have to raise taxes even further to fund its expanded entitlement obligations. Or take on more debt, of course – but we will deal with that monster later.

The combination of increased costs and reduced room for innovation would likely have a dampening effect on private investment – which may prolong the recession and, in a worse case scenario, render null and void the government’s efforts to spur real demand in the medium term.

All of the above is merely the Scylla. But we are also facing a deadly Charybdis.

Because the recovery plan is being funded by massive debt, on top of a situation in which the national debt has already expanded greatly over the previous decade, the government itself risks going bankrupt. With national debt projected to exceed $14 Trillion by 2010, government income will barely cover the interest payments under current income projections. Already, China and other large holders of U.S. government obligations are rethinking their investments in U.S. Securities. And President Obama himself announced at the G-20 summit that the U.S. would no longer be the engine of global economic growth.

For now, the government is somewhat protected because interest rates on short and long term government debt obligations are at an all time low. Furthermore, the global depression will probably result in lower population growth, limiting the budget-draining effect of increasing entitlements. However, if the economic recovery plan works as intended, and the economy improves over the next couple of years, then presumably interest rates will rise again. If this happens, the government may not be able to cover the interest payments on its debt, and just like that we’re out of business.

But for the current scheme to work, real GDP growth would have to greatly exceed inflation such that rising incomes and increasing demand does not spur large disproportionate price increases in capital and consumer goods. This means that American workers and industry must find ways to increase their efficiency several fold over the next few years. Thus the stimulus plan’s investment in education seems to make particular sense when viewed as a means of fostering a more competitive work force. It will be interesting to see whether or not these retooled workers, thinkers and entrepreneurs can come online soon enough to stave off the inflationary effects of increasing demand.

Getting through these tough and treacherous times will be difficult but not impossible. The real question is whether the current administration understands the full implications of its policy choices as it navigates through these dangerous straits. And whether, ultimately, it will choose the optimal mix of caution and ambition necessary to save the ship and keep individual fatalities to a minimum.