The Four Roads Ahead for U.S. Economy

The last few days, I’ve been reading various opinions on the US Economy on the web, and thinking that they don’t really get the situation that we are in, both short- and long-term.  I am increasingly disappointed with those proposing Keynesian remedies, because those were what got us into this pickle in the first place, and they think that more of the “hair of the dog” will rescue us from our drunkenness.

Consider, when in the last 40 years has our government not run a deficit, excluding flows from entitlement programs?  I think the answer is has never been so.  Stimulus has been the rule, the only argument has been do we do more or less?

Think of monetary policy post-Volcker.  Who has been willing to allow a recession to harm marginal investments?  No one.  The punch bowl was removed slowly, but brought back rapidly, which brought the applause of politicians, and gave Greenspan the moniker “Maestro,” even though he was driving us into a liquidity trap.  (Maestro, yuck: I’m a gentleman; I can’t express what a disgrace it is to lionize a man who did us such harm.  Execution is out of the question, but can we send him to the North Koreans or the Iranians to have him run their monetary policy?)

Bernanke is little different, having learned the wrong lessons from the Great Depression, thinking that the response from the Central Bank and the Government was too weak.  Rather, they did too much, and prolonged the depression more than it would have otherwise gone.  Andrew Mellon was wiser than them all.

Governments are bad allocators of capital.  They borrow money and allocate it to where the political return is the highest.  Those projects may bump up GDP in that year but do little for future GDP.  This is the lie of C+I+G=Y.  Yes, in the short run that works, but in the long run, money spent by consumers and investors yields far more for growth in the economy than government spending.  Our government is only interested in the short run, given their short-run fixation on the election cycle.

Consumers choose what helps them in the short-run, and Investors the long-run.  The government has non-economic motives — their actions merely harm the situation.  Better they should reduce taxes broadly than try to target certain areas that have clever lobbyists.

All that said, I believe government has a role in regulating commerce.  There have to be standards established so that that people can trust in what they buy, in areas that cannot be easily verified by ordinary people.

The Four Roads

There are four roads ahead for our economy, thought they are not all exclusive, aside from default.  Let me describe them:

Higher Taxes

This is the solution of the aftermath of the Great Depression.  After the huge debt buildup from the depression, the increase in taxes paid off the the debts in the 50s.  Problem: baby boomers and their children are more selfish, and won’t take the same abuse today.

All that said, be ready for higher taxes.


At present the Federal Reserve will not stimulate goods-price inflation.  They will support asset inflation; consider how they supported the money markets when they were under stress.

But there may be a limit to their ability to control matters.


The US Government could never default.  Well it did twice, under Roosevelt and Nixon, when it moved away from its gold-based obligations.

Government receipts would have to double to meet the future needs of entitlement programs.  I don’t think we can get there.  More likely we try to reduce payments, even if already agreed to.


The Japan scenario means survival.  Rather than taking a deserved depression, the economy is forced to support lousy companies that cannot survive otherwise.  They have done that for 20 years.

The Point

My view is that we are going to take deflationary pain anyway, so take it like men (are there men nowadays?).   There may be institutions that fail; far better to deal with them at the most basic level, that of the debtor, than trying to prop up dud institutions.

I have more to say, but I have to go backpacking.  More later.

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About David Merkel 145 Articles

Affiliation: Finacorp Securities

David J. Merkel, CFA, FSA — From 2003-2007, I was a leading commentator at the excellent investment website ( Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and now I write for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I still contribute to RealMoney, but I have scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After one year of operation, I believe I have achieved that.

In 2008, I became the Chief Economist and Director of Research of Finacorp Securities. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm.

Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life.

I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

Visit: The Aleph Blog

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