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A Look Over the New Stimulus Plan

Written by A Forex View From Afar on Tuesday, December 09, 2008

In a televised interview, President-elect Obama announced a new stimulus plan that some believe very likely to help the U.S. economy recover much faster from the credit crunch. Or will it?

Even though the plan was not fully disclosed, the overnight equity markets posted strong rallies. Not fully divulging the coming plan is not something new for U.S. administrations. It all started with Mr. Paulson’s $700 billion fund, of which it is still unclear for what the available funds will be used. The only reference made about the plan was that it will include a public spending program to expand the U.S. infrastructure (e.g. building roads and bridges).

However, from the beginning there have been doubts on how much it will actually help the real economy. The method of “spending the way out of a recession” was first developed in the 1930’s, by Keynes. Back then, most of the economy was based on industry, as extraction of raw materials and their conversion into finished goods. For example, in that period a staggering majority of the Dow Jones index was formed by steel, mining and rail companies.

History shows us that even back then, when the economy was still based on industry, the Keynesian plan did not work properly. First, the U.S. infrastructure is pretty efficient these days, so most investments may not justify their costs. Back then, in the 1930’s, infrastructure was mostly based on bad roads, and mobility was very low. Today, this is not the case. Secondly, if building roads, which eats up a lot of resources, did not help the economy when most of it was still based on industry, how much can it help today, when a huge part of the economy is based on the financial system?

Furthermore, Japan tried to implement an appropriate method to fight deflation in early 2000. Japan faced similar problems as the U.S. economy: credit markets drying up, risk of deflation and zombie banks. Japan invested huge amounts in building roads, highways and bridges, but at the end of the day it still did not help the economy revive in any way. Even today, the Japanese economy is still not working properly. The Japanese bridges and roads built in that period remain known as the “bridges to nowhere”.

In conclusion, there are doubts on how much the plan can actually help the real economy. The market’s answer was pretty strong, but even so, it is hard to see any effects other than widening the Government deficit in the short run. Referring to a longer period of time, the world economy is set to revive by the end of 2009, and from the way construction works, most of these projects will not even start by then

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