Change has come to America. Oh really? - Views on News from Equitymaster

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Change has come to America. Oh really?

Jan 21, 2009

Barack Obama yesterday swore in as the 44th President of America. For anyone who cares about racial equality, these are clearly the best of times given that Obama is first African-American President of the US, a predominantly 'white' country."Change has come to America!" were Obama's first words after winning the presidential elections. Since then, he has taken several steps to formulate his plans for the economic and social well-being of the US, which is currently facing harsh times. In short, it is now Obama's responsibility to take his country and its people from fear to hope...hope for a better tomorrow.

Obama has a big responsibility in restoring the faith of millions of Americans who have lost their jobs to greed of the financial firms and mis-steps of central bank policymakers.

Given the number of people who attended yesterday's oath-taking ceremony, American isn't just expecting Obama to do a good job. The country is seemingly expecting him to do miracles - on foreign policy, economy, jobs, internal security, and everything else.

So, what will Obama do?
While the Americans hope, and expect, and pray for a better future, from what we have seen so far, Obama's economic revival plan is just a little more than Bush's plan in a different garb. Just like his predecessor, Obama is also planning to throw trillions of dollars at the problem that was created due to trillions of dollars.

However, unlike Bush who had the headroom (via the Fed) to bring interest rates to near zero to pump in more of cheap money into the system, Obama is short of this monetary policy ammunition. Rates are already near zero.

So what will he do? Cut rates to less than zero like the Japanese did in the 1990s?

It didn't work for the Japanese. Recession in the country lasted for more than a decade despite sub-zero interest rates. And despite Bush's trillions of dollars in bailout money, around 2.5 m Americans have still lost their jobs and the recession is only getting worse.

Obama, like another former US President Franklin D. Roosevelt*, has also talked about an infrastructure plan that will employ 'millions of Americans'. To do what? Pave roads and dig ditches?

But Roosevelt's 'New Deal' didn't work either! Despite everything he did starting 1933, the US still entered into a deep recession by 1937. Industrial production declined sharply, as did profits and employment. Unemployment jumped from 14% in 1937 to 19% in 1938. As unemployment rose, consumers' expenditures declined, leading to further cutbacks in production.

Despite the mountains of money Roosevelt threw at the Great Depression, it still took ten years and World War-II before the economy came back to life.

Now, if Obama were to repeat these failed policies, how will he be able to produce better results? Following the failed policies of Roosevelt and Bush will only make matters worse for the US and subsequently for the world.

Giving failing companies and consumers more money to make more debt repayments when the debt will eventually go bad, will only elongate this crisis. And if the crisis prolongs, Obama will ensure that many companies that might otherwise survive, fail. Millions of more job losses will follow.

And what he should do?
Instead of repeating the failed policies of the past - of Roosevelt, Bush, and Japan - Obama needs to really do a miracle...something unthinkable. He needs to change the way this crisis needs to be handled.

Remember, the root of this crisis is way too much debt - in the form of mortgages, car loans, credit cards, and high risk business loans. In good times, people took too much debt, more that what they could have handled. In bad times like now, they have lost the capacity to repay. So banks are wary of new lending. Investors are scared of investing in banks and other industries. Companies are not in position to borrow to fund growth and so their profits are declining. Consumers are not in a position to borrow to buy things and so they are restricting their spending further.

Less money for banks from repayment of debt -> less money to lend -> less funding for companies -> less wages -> less consumption -> less production -> less economic growth.

This vicious cycle is repeating itself, even intensifying as time passes.

The way forward for Obama, we believe, should be to cut the wires of this debt bomb. He needs to convince the Americans that the only sensible and intelligent path to recovery is to refuse to spend more dollars to save shaky borrowers. He also needs to explain to his fellow citizens the virtues of saving rather then spending more than the income.

Only after the mess is clear should he go ahead offering companies and consumers tax breaks, loans, and grants they need to help them build the foundation for a strong recovery.

If he is able to tread this path, he will be able to cut short the duration of this crisis. He will also be able to restore faith in the system and end the recession faster.

We hope Obama's "Change You Can Believe In" is not just another campaign slogan and he really acts in bringing about the change in the way Americans live and conduct themselves. Remember, a lost decade for the US will be a lost decade for the world.

Over to you, President!

* Franklin D. Roosevelt formulated the 'New Deal', which was a sequence of programs he initiated between 1933 and 1936 with the goal of giving work (relief) to the unemployed, reform of business and financial practices, and recovery of the economy during the Great Depression.

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