Popular sentiment is that he will launch another huge fiscal stimulus.  But there’s a danger in this strategy because the Federal Government already took on $8 trillion in investments, loans, and guarantees issued over the past year.  It won’t be long before we are looking at the potential doubling of the Federal debt.  And I’m concerned that we are underestimating the international ramifications of this trend.  National markets are far more open and interrelated than they were just decades ago. Therefore, we need to pursue policies that are globally coordinated, especially between Beijing and Washington.

As for a traditional stimulus package that involves issuing checks to households, that may not work because I’m not sure if people will spend this additional income.  They are most likely to save it.  We should be mindful that there is stimulus occurring from the sharp decline in commodity prices and nominal wage growth.

Most important, we must forget about trying to restart the formerly high levels of consumer-driven growth, because so much of it over the last 7 years was based on credit.  If you take away mortgage-equity withdrawal from 2001-2006, growth would have averaged only 1 percent. Households must first improve their balance sheets, as it were, before we can expect consumer demand to again contribute significantly to economic growth.

This suggests that Obama may be more successful if he targets government resources less on trying to stimulate consumer spending and more on infrastructure improvement that would enhance productivity and broader-based economic growth.  It may be that Obama needs to focus more on the medium term rather than the short term. 

Yes!  The current size of the federal deficit is at war-time levels.  Without passage of any additional spending packages, Morgan Stanley estimates it to be around 12.5 percent of GDP.  Under normal circumstances, such as the years leading up to the crisis, the US shouldn’t have been running much of a deficit prior to the slowdown. This would’ve provided the fiscal space to better accommodate expansionary policies that wouldn’t have threatened the overall integrity of the federal budget. 

But now we must be mindful of how this deficit is perceived by foreign investors buying Treasuries.  We are running the risk that one day soon these folks may conclude, “hey, wait a second, the US government is behaving like Argentina or Mexico, and the dollar is looking like some kind of peso.” 

If you get to that kind of sentiment, it can begin to eat away at your status as the world’s reserve currency. Then your government bonds loose the perception of risk-free assets, and the cost of funding your deficits will likely grow much larger.

For some folks there is a certain nostalgia in considering this during a major crisis.  I have trouble imagining how the $50 trillion world economy could be put back onto gold given the relatively modest amount of the metal available to central banks. 

Gold is just a commodity. It’s good for jewellery and it’s a relatively good hedge against inflation and bank panics. But the notion we can reengineer a gold standard is based on a naïve reading of history.  The gold standard was not a Garden of Eden.  Its supposed hey day, between the mid-1870s and mid-1890s, was a time of global deflation.  There was an even more deflationary period during the 1929 and 1931 when the standard basically broke down. The last thing we need during a time of high de-leveraging is a deflationary global monetary system.  That would be suicidal.