American Economy: The Flooded Engine by Josh Sidman

by Josh Sidman
Dandelion Salad
Featured Writer
Oct. 11, 2007

(WARNING: MIXED METAPHORS AHEAD. PROCEED WITH CAUTION.)

Anyone who has had the unpleasant experience of trying to start an old car with a faulty ignition will be familiar with the phenomenon of a flooded engine. When you’re having trouble starting a car, it is usually effective to step on the gas pedal while turning the key in an effort to force-fire the engine. However, this procedure can become counterproductive if used to excess. Eventually too much gas is administered, and the engine will not start again until the excess gasoline has had time to drain off or otherwise dissipate.

The phenomenon of a flooded engine is an apt metaphor for the current state of the American economy. The engine of our economy has been run in such an irresponsible and unsustainable manner that the only way to keep it from collapsing is to continuously add more fuel to the fire. The only thing that prevented a crash in 1999 and 2000, when the internet bubble burst, was an extremely high dose of liquidity added to the financial system by the Fed. Short-term interest rates were slashed to one-percent – a measure that could only be considered “emergency medicine”. The Fed’s action succeeded in averting a crisis temporarily, but the real effect was simply to postpone (and magnify) the eventual reckoning. The medicine used to deal with the collapse of internet stocks only served to create an even bigger bubble in the real estate market.

Monetary policy is proven effective at influencing macroeconomic conditions in the short-term, but it is only a temporary remedy. If the long-term fundamentals of the economy are not addressed, a point will eventually be reached where the medicine doesn’t work anymore. Similarly to how the human body becomes resistant to antibiotics if used to excess, each new injection of monetary stimulus, if not accompanied by real economic reforms, will become increasingly ineffectual. And, in both medicine and monetary policy, when effectiveness has been reduced, the short-term temptation is always to administer larger and larger doses, even if the long-term health of the patient is jeopardized. If the patient is fundamentally healthy, medicine can be used to speed the process of recovery and alleviate the suffering associated with it. But if the patient is fundamentally unhealthy, medicine itself can become be lethal.

It is in these terms that I have come to view the current state of affairs with regard to monetary policy and the financial markets. Lately we have seen the stock market rallying on the expectations of rate cuts. Whenever you seen this phenomenon, there’s always an element of irony. In the long-run, the stock market rises and falls in tandem with the health of the underlying economy. Rate cuts are normally administered only when the economy is less than fully healthy. So, stock market rallies fueled by anticipation of rate cuts are a bit of a macabre phenomenon. Its like celebrating the euphoria of anesthetics when the reality is that the body is sick and is about to undergo an invasive procedure. This is what we are seeing in the financial markets at the present time. The stock market remains near all-time highs in spite of the fact that virtually every data-point in the real economy is negative. The real estate market is collapsing, the dollar is losing value rapidly, the government is increasingly indebted (as are more and more of our citizens), companies are going bankrupt, unions are striking, and we’re spending hundreds of billions of dollars a year on a wholly unproductive war, but the stock market makes new highs. Something just doesn’t add up.

Clearly, the wishful thinkers at the Fed and in the financial markets are not ready to give up the ship just yet. They’ve still got a supply of medicine to keep the patient alive for a little while longer. It is therefore likely that we’ll see a continuing policy of monetary stimulus via additional rate cuts, which will ignite a few more euphoric rallies in the stock market. But the rallies will become increasingly anemic as it becomes clear that the Fed is running out of ammunition and that nothing is being done to cure the fundamental health of the economy. Once this reality hits home, people will start to run for the exits, but by that time it will be too late. The value of the dollar will have been decimated, the savings of American families will have been inflated away, millions of people will have lost their homes, and THEN the stock market will collapse. This will be the point at which we have metaphorically flooded the engine. We will eventually learn that no amount of additional gas will start the car, and we will have no choice but to go through the unpleasant experience of feeling the full force of our sickness. Hopefully, then we will start to figure out what we can do in the future to cure the patient, rather than just further anesthetize it.

Advertisements

2 thoughts on “American Economy: The Flooded Engine by Josh Sidman

  1. It’s good to hear someone speak the truth using a very apt metaphor. We’ve put off the day of reckoning so long, the fall is going to be long and hard.

    Many think that all the social nets that have been put in place will soften the fall. i would ask: how? We’ve already spent and pissed away the money to fund these, so called, nets.

Comments are closed.