Yup, we are stuck in a liquidity trap.

Month after month, there are always a few stats that remind us how the US Economy has been affected by the current recession. Some say we are out of it (you can play around with numbers as you wish, right?) but in reality, the unemployment rate is very high, the housing market is still shaky and consumers’ confidence is wavering like a mobile home facing Big Earl.

What is a Liquidity Trap?

A liquidity trap happens when there is a recession caused by a credit crunch. At first, banks will restrain their credit policies because they are having a hard time keeping their head above water. While consumers can’t really borrow more since banks won’t grant the credit, they also tend on the other hand to save more money and pay off their debt since they are afraid of losing their jobs. Then, on their side, corporations keep a high level of liquidity because they are not convinced that the economy will bounce back right away and they certainly don’t want their banker phoning to call back a loan (remember Lehman’s story anyone?).

Therefore, the whole economy is stalled because:

- Banks don’t lend money

- Consumers don’t spend money

- Companies don’t invest money.

In a few words; a liquidity trap happens when everybody keeps their money in their pocket.

How to get out of a liquidity trap? How will the US economy bounce back?

The usual method is to drop the interest rate in order to encourage consumers to borrow and corporations to invest. However, having rates at 0%-0.25% makes it difficult to drop them lower . Now, the Fed has to consider other options:

2011 Stimulus Check

Offering stimulus checks in 2011 could be an option to invite people to spend this money in the economy. However, if consumers use this money to pay off their debts or to build an emergency fund (top options that really makes sense), the stimulus check would not help the economy and leave it in the liquidity trap.

Buy back bonds

Another way to inject more money in the economy would be for the FED to buy back Government bonds. This would inject more money into the market and hopefully toss away the liquidity trap. This measure is currently considered by the FED.

Wait…

Yeah, that sounds like a pretty lazy way to take care of a problem, isn’t? In fact, the US Gov’t injected a lot of money through their bailout program, 2010 stimulus checks and they smothered the credit conditions throughout their rate policy.  Therefore, the FED is well aware that they are stuck in a liquidity trap and they applied a lot of measures to get out of it. Yet, one solution is to wait and let these strategies slowly take the economy to the track of growth again. Slowly but surely, the confidence in our economy will be reinstated and the problem can be solved.  The question is: with mid-term elections coming, will the Gov’t be patient?

image credit

So they “technically” saved $13 billion. Was it a good move? I don’t think so, and I also think that there should be additional help for students!

The idea behind the Stimulus Check Process

The very first premise of issuing stimulus checks is that most of the money distributed by the government will come back to them through the taxes paid by consumers and workers that keep their jobs since people keep on spending. Basically, they prime the economic machine with fuel in order to generate economic activity.

Technically, it can work since you can count on most individuals to spend this money and “apply” the Government plan as expected. However, if someone decides to save this money or pay off debt (which would be a great idea, though!), this money does not fuel the “economic machine” and ruins the Government plan.

In the end, stimulus checks were also a great way to gain some political points too!

Why a Student Stimulus Check in 2011 Would Be A Good Idea?

I think that creating a stimulus check program for students would be a great idea because it would help to support the taxpayers of tomorrow. In a rough economy, we certainly don’t want to have promising students discouraged and overwhelmed by debt to the point of quitting school.

Since part time jobs are difficult to find, and full time jobs even harder. Many unemployed individuals will take any job on the market to pay the bills until they find something better. These are the jobs usually occupied by students. As a result, it can become harder for them to get a part time job and pay for their tuition.

Apart from student loans and grants, a additional stimulus check would be a great way to encourage students to finish their studies.

Since educated people tend to get better jobs, higher salaries and pay more taxes, the stimulus check for students would be more like an investment in future taxpayers instead of charity for those who don’t work.

Do we have any chance of seeing another stimulus check in 2011?

While I think it would be a great move from the government (especially since they still have 50% of their 780G$ allocated for spending), I haven’t seen any mention in the newspapers about the next stimulus check.

It seems that the biggest concerns were concentrated on the healthcare system and then toward the tragic oil spill (thx to BP!). Unfortunately, we live in a world of emergencies and creating new stimulus check programs is not one of the most urgent things to do right now!

Image credit

All of this because of this kind of video:

We have to thank the Greek for this investing opportunity!

Call me stupid, call me contrarians, I am confident that this is a great investing opportunity! The financial problems in Greece will open the door to great buying opportunity on the stock market! I think that, as it was the case with the credit crunch in 2008, the investors reaction is way over what it should be.

Why is the US dollar so weak?

The relative strength of a currency is first linked to a country’s finance. Try looking at the country as a person. If you open his Microsoft Money, you will see that the US Government has a few problems with his balance sheet.

First, there are credit problems: banks are still struggling with several foreclosures while many Americans are wondering if they would be better off turning in the keys to the family home instead of continuing to pay this huge mortgage for a house worth far less than its debt.

Second, the US government injected an incredible amount of money into its economy. Most economic stats are currently boosted by this help. Therefore, we all know that the true economy is still in a hospital bed.

Third, investors in general are still riddled with fear instigated by the US economy. This is probably why the greenback is so weak. Global investors fear that the recession is not over and that more bad news is yet to surface. This is why they are less tempted to invest their money in the US market.

It’s not all that bad though…

As I mentioned in my title, there are a few reasons why a weak dollar could help the US economy:

Reduce the risk of deflation

When the economy goes bust, consumers generally reduce their spending and interest rates go down as well. This is when prices stabilize or even decrease for certain goods (since the demand for them has dropped, if you still want to sell something, you have to drop your price). This is what we call deflation. If the price of goods drop, salaries will do the same thing and the economy won’t grow. You can see that it’s not the perfect scenario.

However, if you are stuck in the middle of a recession and your currency drops in value, things that you import will be higher in price. This won’t help consumers but it will help to maintain prices higher so the economy can start up again.

Increase exports

If importing costs more, obviously exporting your goods will be more beneficial for countries with stronger currencies (they get more for their buck!). In turn, this will stimulate US industries to produce goods at a “lower” cost and will generate more profit (in US dollar). This is how jobs on American soil can be saved.

Productivity at its best

Americans are well known for their efficiency and productivity. During rough time, companies cut down on expenses and demand more from their employees. This is often when we see the highest productivity gains; when you solicit your brain, you often get marvellous results .

So the US dollar weakness is temporary but will still serve the economic growth on a short term basis. This is why I don’t expect the Fed to make any moves to help the greenback in 2010…

Paddy Hirsch explains what happened to the toxic assets.

If you’re looking for a way to improve your financial  and  economic knowledge, you may want to check out Marketplace’s Whiteboard series. I really enjoyed watching Paddy Hirsch explain a little bit about where the toxic assets mentioned in the news.

Some other topics you might want to check out include:

Meet Cap ‘n Trade

The public-private partnership

Collateral calls

Write-downs

A look inside hedge funds

Leveraging and deleveraging

Why ‘Fallout’ for the financial crisis?

How credit cards become asset-backed bonds

Thanks to Consumerist for the link!