Vigilant Investments Advisors, LLC.

What Happens Next Time?

Currently the United States is preparing to stimulate its economy with a multi-Trillion Dollar approach.  The problem of the economy is seen as so severe that only a stimulus and bailout package of several Trillion Dollars will impact and improve the situation.  The looming question is, “At what dollar amount will a stimulus fail to be a stimulus?”

Unfortunately for the stimulus party, it can only work in the right proportions relative to the underlying economy.  If the stimulus is larger than the Gross Domestic Product of the underlying economy, the stimulus will cause more domestic and international concern and will cause greater uncertainty.  In general, this is being considered by our current set of politicians; however, another more-dire concept is not.

The capitalist economy of the western world cycles every four or five years in a set of micro-cycles with larger macro-cycles coming every 50 to 70 years.  The micro-cycles can be affected by fiscal and monetary policy.  In addition, correct policies can significantly shorten these cycles and can significantly mitigate the negative effects of the micro-cycles.  However, there is a cost to this intervention that will ultimately bear itself out by either causing the micro-cycle gains to be muted, or—as in our case today—to cause the macro-cycle declines to be much more devastating.

For example, if monetary and fiscal policy is used actively to stimulate the economy, the deficits caused by the stimulus must be recovered before the next cycle otherwise the stimulus option is not available during the following cycle.  This “recapture” of the stimulus that is spent is a drag on the expansion part of the cycle and effectively mutes the gains during the expansion.

If the government spending during a fiscal and monetary stimulus is attempting to mitigate a large macro-cycle decline, the spending and stimulus must be so significantly large that the larger cycle is muted.  Unfortunately, if the stimulus is mis-guided or in-effective, the created fiscal and monetary deficit must still be recaptured prior to the next economic cycle.

The challenge in the case of the United States is that the economic cycle is definitely a larger, macro-economic cycle.  The stimulus is definitely larger and more costly.  The question is, “Can or will the government be able to tax the people enough to recover the deficit prior to the next market cycle?”

In this case, the economy will respond to the stimulus because the stimulus will likely cause a deficit that is will increase the national debt to be roughly equal to the annual Gross Domestic Product of the United States (current GDP or 14 Trillion and National Debt of 10.6 Trillion).  If this stimulus grows the national debt by over three trillion dollars, the GDP and National Debt would be roughly equal.

It begs questions of how much more debt can the government borrow.  For example, what would happen if the country was forced into an expensive oversees war?  Or, what would happen if the economic stimulus plan doesn’t work?  Or, most certainly, what will happen during the next economic downturn that will surely come in the next few years?

Have we entered the same cycle Japan did 19 years ago?  How much can the government spend before they have nothing left to spend?  What will happen to the economy when that happens?

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