President Obama took a serious misstep by veering sharply to the right and pursuing an unnecessarily (according to this analysis by Nate Silver, among others) draconian and conservative approach to the debt ceiling negotiations. In my view, the President gets his economic advice from someone determined to inflict further economic pain and render him a one term president. Ironically, my view does not differ much from former economic adviser Lawrence Summers.The market reaction to the so-called debt deal ranges anywhere from brutal to horrific. Sine the weekend "deal," the Dow extended its losing streak which right now exceeds any since the meltdown in 2008. The Dow fell 265 points today and Asian Markets right now are all off similar amounts. The flight to safety caused gold to soar, Treasuries to trade higher and Spanish and Italian bonds to fall.
The essential problem is that the global economy desperately needs stimulus and austerity has run amok most notably in the US which was the last source of stimulus, however modest. As The Economist puts it: "action needs to be taken in the long term to tackle the US's fiscal burden but too much austerity in the short term risks damaging an already fragile economy." I argued last week that the dismal GDP mandated stimulus now and austerity later. This week a fresh report shows that the American consumer is simply in too much debt to continue spending and cannot fuel any growth. Elsewhere, the Eurozone appears on the brink of a major crisis as Spain and Italy both face prohibitive increases in the cost of rolling over their debt.
When an economy reaches a liquidity trap (massive capital flight to safety such as cash, excess reserves, Treasury obligations, and precious metals) only the government can convince investors to take risks again by credibly pursuing fiscal shock and awe (like World War II), as I first argued in December of 2008. Tax cuts will not work because people will save them. Monetary policy will not work because it leads to excess reserve accumulation at the Fed. Only massive government spending and employment programs will lure capital out of hibernation once an economy reaches the zero bound.
The debt deal is directly opposite to what the economy needs--more stimulus.
The Obama Administration appears determined to perish in order to vainly defy this basic truth. That is the only explanation for the Obama debt deal.
Maybe the Fed should charge banks to keep the excess reserves. That'll get some credit flowing!
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