Addicted to Stimulus

The picture to the left is a line of Meth. As many of us know, Meth is a stimulant, offering the user pep, focus, energy and confidence. Most of us use stimulants without realising it. Caffeine and Nicotine are stimulants. My drug of choice is caffeine, and I will be brewing up a batch on my stove when I finish writing this article.

But it's not as though stimulants aren't very useful. A cup of coffee can really get your day going. Moreover, it's a well known fact that the US Air Force plies its pilots with stimulants to give them focus and energy when they are flying often (especially during combat), thus allowing them the "cheat codes" to avoiding weariness while flying multi-million dollar machines.

But, as we know, stimulants can be dangerous. The short term positive effects can be outweighed overwhelmingly by long term negative effects. These include becoming "jittery", overconfidence, personality changes and an inability to understand things properly. This is why we see Coke and Meth addicts acting strangely not just when they get their Jones, but also when they have had their shot. Addicts often discover that long-term addiction to stimulants are needed just to make them feel "normal".

I'm obviously using this as an economic metaphor. As the economic crisis deepens, calls for more stimulus are growing louder. Moreover, those who disagree are thrown into the "Hoover" bin, who made the mistake of raising taxes during the depression.

By itself, increasing government spending to stimulate the economy is a good thing. Keynes pretty much proved this decades ago, and economic downturns around the world have often been cushioned by deliberate increase in government spending - whether in the form of expanding government services or in the form of "stimulus checks" sent to citizens or in the form of tax cuts given to households and/or businesses.

And just like a pilot popping Amphetamines before embarking on a dangerous mission, so can government stimulus be necessary as it embarks on an economic rescue mission.

But here's the problem - the US economy is already addicted to stimulants. The level of Public Debt is 44% of GDP and growing, and this is hardly the worst it might get.

This means a couple of important things. First of all it means that any additional fiscal stimulus will be limited in scope - rather than creating growth, it may only help the economy move slightly closer to "normal". Secondly, it means that the addiction gets worse, which results in even worse conditions later.

I have never had the displeasure of being addicted to hard drugs. The worst I ever got was about 17 years ago when my coffee pot broke and I refused to drink instant coffee and had to endure caffeine withdrawl. Real drug addicts - those addicted to Meth and Cocaine and others - have to undergo a painful period of "cold turkey" in order to rid themselves of their drug dependence. The cold turkey process is not fun - it is apparently a period of intense pain and illness lasting several days as their body reacts to the chemical imbalance.

Go back to economics and you see a similar picture. Nations which are addicted to stimulus - to net growth in government debt - will find it incredibly difficult to cope with the current economic crisis. Added stimulus will not only be less successful, it will also depress the economy in the long run.

One of the more basic things I discovered early in my "learning economics" days was that short-term stimulus - either through budget deficits or lower interest rates - resulted in a downturn later. Similarly, a short-term contraction - either through budget surpluses or higher interest rates - resulted in a return to growth later. The economy responds to these changes by rebalancing itself.

I'm writing all this because at some point in the future, the government will simply run out of things it can effectively do. Bailouts and stimulus checks are all very well at the moment, but in 6-12 months time, will we still be talking about further bailouts and stimulus checks? At some point, someone has to get up and say "No more. We can't afford to bankrupt the entire economy in order to save it".

And this is where the US Dollar comes into it.

The US government has already dug itself into a substantial fiscal hole since 2001. Now with the entire world gripped in an economic crisis, the US does not have much fiscal room left to use. It's a damned-if-you-do, damned-if-you-don't scenario. On the one hand, cutting spending and/or raising taxes might seem too "Hoover" to succeed. But, on the other hand, running even bigger deficits will bring the nation closer to bankruptcy, making investors nervous.

And when investors get nervous, they begin to sell. In this case, the US Dollar may plunge.

Check out how the US Dollar has performed in the last 12 months. For some, the sudden upturn in the value of the US Dollar indicates a boom, a "bull market" in the US Dollar. For others, this sudden upturn can only result in a sudden downturn, as investors pull out of a investment bubble. Since perpetual, permanent upturns went out with copies of Dow 36,000, the only realistic result of the current dollar boom appears to be a bust.

Months ago I recommended a series of policy goals that went something like this:

• Cut military spending
• Raise taxes on the rich
• Run a fiscal surplus to pay back public debt
• Use monetary policy to keep inflation low
• Create and enforce stricter financial regulation so (a financial bubble) doesn't happen again
• Fire Ben Bernanke

These goals are based broadly upon The Washington Consensus, a set of policy goals that the IMF requires of third world nations in financial strife. Sadly, these have gone out of favour after the Asian crisis - yet I cannot see any other way. At some point the US government can do no more than fix its own problems and then sit back and wait for the economy to sort itself out over time.

Sounds horrid doesn't it? Imagine it - Obama and Congress cut spending, raise taxes and instruct the Federal Reserve to keep a tight rein on inflation, while at the same time US businesses are going bankrupt and unemployment pushes into double figures. Not good is it? Painful isn't it? Imagine the outcry and the complaints. Imagine all those people losing their jobs and falling into poverty. But it reminds me of something.

It reminds me that cold turkey is the only way to get off destructive drugs.

The alternative to the policy goals above is "MOTS" - more of the same. More debt, more government spending, looser monetary policy. And that will lead to? More addiction to debt.

Faced with a nation out of control fiscally, investors will panic. The US Dollar will tank. And the US won't have enough money to satisfy its Jones any more. Think about 1930s unemployment with 1970s inflation and you'll get the picture.

The US is damned if they do and damned if they don't. The choice is between a painful period of cold turkey or an even more painful period of cold turkey. There's no "magic bullet" that will make things better.

As for me, I'm enjoying my coffee.