There is very little in the world more frustrating than watching people try to solve a problem with a method that you know will not only not work, but which will in fact create an even bigger problem. That is where we are with the “economic stimulus” package now winding through Congress is just such a disaster.

It helps to understand a little macro-economics. (Oddly enough it helps more to understand a little, than to understand a lot…because then you start understanding too much, you think you are smart enough to see an exception to the rules.) There really are three things that have been at work for a while to put us in the position we are in; the Gross National Product (GDP), the Demand level, and the rate of inflation. In a nutshell, the housing bubble (caused by our Democratic friends in Congress) artificially inflated the GDP. In economic terms, the “real” GDP exceeded the “potential” GDP. In real easy terms, the population was spending more money than the output of the country warranted. We were able to do that by running up debt, but more importantly, by borrowing against make-believe value in our homes. 

Now normally, this situation is self correcting. According to economists, when the demand causes the “real” GDP to exceed the “potential” GDP, prices rise to bring things back into alignment. However, the fed has been so scared of inflation, that they haven’t allowed this to happen. So instead, people continued to take money out of their over inflated home values to buy things that were priced lower than they should have been given production levels. Eventually, this Ponzi scheme of housing prices exploded. There is no place for Americans to go to get money they don’t have to pay for items they can’t afford. 

So basically, the growth of the GDP for several years has been overstated. What we have here is a correction. The GDP will come back to reflect the actual money that Americans earn in a year, instead of that amount plus the amount we took out of houses whose value was inflating while the rest of the economy was flat. Using a historic relationship between GDP and unemployment, an unemployment rate of 10% would translate to a total GDP contraction of about 7.5%. 

That is where we are. Now borrowing $1.5 trillion is only going to fix this one way, the government can try to artificially pump up the GDP again by creating supply where there is no demand. The result will be that the GDP will continue to fall, but that inflation will insert itself rendering the money that folks have been able to hold onto less valuable. This is a little condition known as stagflation that hasn’t happened since J Carter was President. The result will not be pretty. 

So what is the solution? Simple, do nothing. The economy will right itself. Once the GDP stabilizes, unemployment will stabilize along with it. The GDP will begin to grow again at a normal pace until the next government or industry induced bubble. The path the Government is taking, unfortunately, is a trip to our own “lost decade” much like the Japanese in the 1990’s

Stay tuned, and keep your fingers crossed.