Throw another cast and keep the faith

Like many of our readers, I watched in horror Thursday as the stock market melted down, trimming the Dow Jones Industrial Average by more than 500 points, erasing all of the year's gains.

The Dow and the S&P 500 are now both in negative territory for the year. The stock market losses have been compiling since a national debt ceiling bill was approved in Washington, D.C. on Tuesday.

The conventional wisdom in the weeks leading up to the Congressional vote on the bill was that if the debt ceiling was not expanded, the nation would default on its debt and a national economic disaster would then follow.

So, why would the stock market collapse after a deal was struck?

For the answers, I turned the smartest economic expert I know, Dr. Michael Knetter, president of the University of Wisconsin Foundation. Knetter is sort of the BizTimes resident economist, as he provides a macroeconomic outlook every year at the Northern Trust Economic Outlook Breakfast presented by our company.

Knetter, who was a staff economist for President George H.W. Bush and President Bill Clinton, has a way of sifting through and around the partisan garbage and cutting to the economic truths of the matter.

So, in this hour of my darkest need for information and solace after the market collapse on Thursday, where was my economic guru?

The email response came back a couple hours later: "Just back from a great dinner at the White Stag between Rhinelander and Eagle River."

Knetter, you see, is a Hodag. The Rhinelander native was on vacation back in his homeland in northern Wisconsin, worried more about baiting his hook than the Wall Street drama of the day.

Still, he was kind enough to take time between casts to provide answers to some of my urgent questions. I share excerpts from our email exchange with our readers:

Steve Jagler: Was extending the debt ceiling truly something that was needed to prevent default?

Michael Knetter: The ceiling needed to be lifted to prevent a "technical default" in that absent lifting, the government would have been prohibited from borrowing funds needed to meet obligations. But it was hardly a "real" default situation - the U.S. Government still borrows at very low rates, so lenders do not seem worried about ability to pay at this point.

SJ: Does the bill tie America's hands into not investing its future - i.e. infrastructure, education, technology, medical research, alternative energy exploration?

MK: America needed to reduce the gap between spending and tax receipts. Whether this will reduce spending on infrastructure-type investments depends on the specific choices we make. We will have to reduce some types of spending to eliminate the deficit. It will be up to politicians to decide which expenditures are most important – i.e., trade off entitlement programs with infrastructure investments. Infrastructure spending would in theory do more to raise future productivity. But alas, bridges, highways and trains cannot vote!

SJ: The stock market absolutely tanked after the debt deal was signed. Do you fear that this debt deal, with its triggers, cuts, etc., is too severe?

MK: I think we've thrown all the fiscal stimulus we can at the problem. We need to move toward a more sustainable path. This deal may not be the best way, but putting it off would mean more serious consequences later. We stopped the chaos of late 2008 and early 2009 but we haven't dealt with the full range of underlying issues – especially entitlement commitments that look harder to fund. We gotta take our medicine at some point. The market may have thought we would kick the can again and keep things rolling ahead. This correction may not be so bad. Time will tell. But I know what you are worried about – did we just have a two-year dead cat bounce and now find ourselves sliding to depression? Possible, but I doubt it.

SJ: Could the debt ceiling bill cause a double dip and derail the recovery?

MK: That's possible. But not acting to reduce the deficit would have had adverse effects by keeping interest rates higher and postponing the adjustment in spending.

SJ: Will the wealthy – the so-called "job creators" – and corporations that have received steep tax cuts now see fit to invest in their companies and create jobs, allowing the wealth to trickle on down to everyone else?

MK: I think this decision on the debt ceiling will reduce uncertainty about the direction of policy. That should help long-term decision making on investment.

SJ: Or was that an absolute fallacy?

MK: Nope. I think since the onset of the financial crisis I have consistently said the policy challenge is to have some stimulative spending in the near term while also having a credible policy to gradually restore fiscal balance over the medium term. We haven't done very well on that last part! And that's where the tough choices live: between entitlement programs that appear to have gotten too rich for our current ability to pay and needed infrastructure investments. Also, like you, I am worried about the road ahead. I concur with Ken Rogoff's recent column on the Project Syndicate webpage. Well, I hope you enjoy your family vacation up here. I grew up in Rhinelander on the river so this has been a real treat for me. Fishing, boating and golfing every day! Fishing has been great.

The man has his priorities straight.