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Obama's Recession Fix

Right Track

So President Obama appears to have it about right: Government spending, including state and local, for a quick fix; temporary tax reductions to help households pay down debt and, eventually, spend the money to strengthen the private sector; and no permanent tax cuts that would stick us with even worse deficits than are projected now.

Senator John McCain, an opponent of the Obama plan, raised the deficit issue last week -- although only in the context of spending, not of tax cuts. “We need to have a commitment that, after a couple of quarters of GDP growth, we will embark on a path to reduce spending to get our budget in balance,” he said.

Shades of 1937. In that year, the economy was improving and Roosevelt -- on the advice of his bankers -- turned conservative. He cut government spending, raised bank reserves and increased interest rates. It was a disaster. The U.S. plunged into a second recession.

‘Error of Optimism’

In February 1938, the economist John Maynard Keynes wrote FDR a reproving letter, saying he’d fallen into an “error of optimism.” Cleaning up insolvencies and establishing easy money was a precondition for recovery but not recovery itself, Keynes wrote. Government-aided investments, in “housing, public utilities and transport,” should have continued, he wrote, until it was clear that private demand had grown strong enough to carry the recovery up.

Currently, we’re enduring the worst recession, for depth and duration, since the 1930s and the broadest global recession since 1948. We don’t want to repeat FDR’s mistake. By embedding longer- term infrastructure programs in the stimulus package, Obama’s plan provides continuing support for GDP and jobs.

At the moment, expectations are rising that the aggressive, yearlong drop in interest rates, plus the fiscal stimulus, will produce results in 2009 rather than 2010. The weekly leading indicators compiled by the Economic Cycle Research Institute stopped falling in December and rose a bit through early January, although not by enough to call a turn in the economy, says ECRI managing director, Lakshman Achuthan.

Preparing for the Turn

“My fantasy,” Achuthan said, “is that the stimulus coincides with the natural forces that will turn the business cycle up.” Such a recovery could be strong enough to create the jobs needed to stabilize housing prices. Nothing in the data, however, predicts this yet. When the cycle does turn, Achuthan would favor investments in commodities, Treasury Inflation- Protected Securities and other inflation hedges.

(Allan) Sinai expects higher corporate earnings by yearend, based on the size of the write-offs and cuts in labor costs he’s seeing now. “People in safe financial positions might think about deploying some money in stocks,” he said. “There could be a bear market rally, with some chance of starting the next bull market.”

The next challenge will be the shocking government debt and deficits that are shaping up. But first, the policy makers have to get the economy moving again.