America's Looming "Stimulus Trap"

By: David Heacock

Peter Schiff, Austrian economist and CEO of Euro Pacific Capital, just released an article that methodically analyzes the United States economy’s credit conundrum. He critiques the Keynesian belief that an economy cannot recover from a recession without massive spending increases. Schiff writes: “Putting aside the dubious proposition that the human desire to strive and succeed can be permanently short-circuited by an economic contraction, and that modest expected price declines can quell our desire to consume, the Keynesians have overlooked a much more dangerous and demonstrable pitfall of their own creation: something that I call ‘The Stimulus Trap.’”

This “Stimulus Trap,” he goes on to explain, is what has stagnated the Japanese economy for over a decade and is likely to take effect in the United States. Under this scenario, an economy that becomes dependent on the central bank’s stimulus, will fail to allow assets to shift to productive sectors thatprovide long-term, sustainable growth. “The condition is characterized by anemic growth and deteriorating underlying economic fundamentals which is often masked by inflation or asset price bubbles.”

Schiff also points out how the Fed’s policies are directly tied into politics. He explains that if the Fed were not buying the bulk of Treasury debt, interest rates would rise, increasing the cost of debt and forcing Congress to decrease government spending. There will come a point where the Fed will have to cease this practice, meaning the government is going to have to address its over-spending addiction and abruptly restructure its programs. This will necessitate real cuts, unlike the phony, so-called “devastating” $85 billion sequester that so many lawmakers scared the public over a few weeks back.

While the Keynesians are rooting for Fed Chairman Ben Bernanke to call the shots in an eventual exit strategy, in reality, this prospect is doomed to fail. Schiff likens the task to pulling “the monetary tablecloth off the table without disturbing the dishes… In truth, the trick Bernanke must actually perform is to pull the table out from beneath the cloth, leaving both the cloth and the dishes suspended in air.” It is simply impossible to remove the Fed from the economy when the system is dependent on its reallocation practices.

“ny talk of an exit strategy is just that, talk. Not only can the Fed not exit, but it will have to delve further into the stimulus abyss. While doing so, the Fed will continuously insist that the exit lies just behind an ever moving horizon. It will repeat this mantra until a currency crisis finally forces a painful exit.

Unfortunately, the longer the Fed waits to exit, the more painful the exit will be. But trading long-term pain for short-term gain is the Fed's specialty. In the meantime, Wall Street watches in uncomprehending stupor as the economy settles deeper and deeper into the stimulus trap.”


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