Rev up the helicopter

With official interest rates near zero, the US may as well start printing money to bail-out Detroit – and everyone else

Richard Adams guardian.co.uk,
Wednesday 17 December 2008 20.30 GMT

The worst piece of economic news coming out of the US in the last week wasn't yesterday's move by the Federal Reserve to cut its fed funds interest rate to a Depression-era floor of zero. True, the fact that official interest rates are hovering around 0% is eye-catching, but the move was more symbolism than anything else – since some US Treasuries are already being traded at close to zero interest. In other words, the Fed's cut was merely a reflection of reality.

(And in case anyone in the UK or Europe was feeling smug about this event, don't worry – the Bank of England and the European Central Bank will be joining the "zero club" soon enough in 2009.)

And no, the worst piece of economic news wasn't even the more significant discovery that US consumer prices fell by 1.7% last month, given that it raises the spectre of deflation, a dangerous spiral of falling prices and consumers sitting on their hands, asking why they should buy now when things will be cheaper next month?

No, potentially the worst piece of news passed by almost without notice: the decision by the Japanese carmaker Toyota to hit the brakes on its construction of a new factory in Mississippi. That decision wrapped up the past and future prospects for the US into one unhappy package. If Toyota cancels its plant, the US economy won't collapse, of course. But it is more than just a bad omen. It's a warning of what is to come for the Federal Reserve and the incoming Obama administration.

Toyota's new car plant wasn't just any assembly line. It was to be the first US factory to make the famous Prius hybrid. Toyota had already invested $300m in it – but it may prefer to kiss that money goodbye than commit the extra $1bn needed to open it. That's a vote of no-confidence in the US economy for starters. More importantly, the Prius was to the 2000s economic bubble what the Aeron chair was to the dotcom boom. For the last couple of years it has been impossible to buy a new Prius off a dealer's lot – the waiting list was too long. Then the sharp spike in the price of oil this year gave another reason to buy the fuel-efficient Prius. Hence Toyota's decision to build a plant in Mississippi.

But let's not forget that the major economic story of the last couple of weeks – before Bernard Madoff made the front pages – was the begging by Detroit's Big Three carmakers for a government bail-out.

Opponents of the bail-out made much of Detroit's inability to compete with the Japanese manufacturers such as Toyota (a situation largely the result of Congress's decision to restrict car imports from Japan in the 1980s, but that's another matter), arguing that this would be throwing good money after bad. Most Republicans opposed giving the money to General Motors and Chrysler, including those southern senators who boasted a thriving car industry based on new foreign car factories built in their states.

Among the Republicans who shot down the bail-out were Roger Wicker and Thad Cochran, the senators from the great state of Mississippi. But here's the question that could haunt them and their constituents: if the Detroit bail-out had passed, Toyota would have been less likely to have put its Prius factory on ice, and the 2,000 jobs that were to come with it. (Toyota has a choice that GM doesn't have. The Japanese firm can scrap its plans for Mississippi and ship in cars from Japan instead. But that doesn't bring any jobs to Tupelo.)

After all, it's not just sales at Ford and GM that are suffering: in November 2007 Toyota sold more than 16,000 Prius models. Last month it sold just 8,000. The problems of the auto industry are long-term – over-capacity, in the main – but with a short-term kicker: car sales are intimately connected to personal borrowing, since most Americans rely on loans to buy a car (especially new ones). Since the credit crunch has trickled down from Wall Street, it has become harder to get credit to buy a car, since lenders are now more cautious. On top of that, the state of the economy is such that people are delaying a big purchase like a car (or a house) if their income is being squeezed and they decide to pay off earlier debts. Even cutting prices may not work. The dreaded deflation effects mentioned above may make matters worse.

Toyota won't be the only foreign investor changing its plans in the face of a recession. Rebuilding US balance sheets, both commercial and personal, is going to take some time, as businesses and consumers untangle themselves from debt. That task will be made longer and harder if the dinosaurs of Detroit collapse, whether they deserve to or not, or if a new wave of manufacturers such as Toyota are scared away by the toxicity of the economy. (Toyota was receiving subsidies worth $300m to build its Mississippi plant, in case anyone thinks only Detroit has carmakers who want government funds to help them.)

The woes of Toyota and Mississippi, GM and Detroit, and the fed funds rate hitting zero are all connected. The US economy – along with much of the rest of the so-called developed world – has entered what economists call a "liquidity trap", where holding cash (which earns 0% interest, but is entirely safe) is as good an investment as any other low-risk asset. At that point, central banks may as well just print money to re-inflate their economies – as the FT's Martin Wolf remarked: "As Robert Mugabe has shown, anybody can run a printing press successfully." (Certainly, deflation isn't a problem in Zimbabwe.) In that case, why not bail-out Detroit and offer zero-interest loans to the likes of Toyota as well? After all, building eco-friendly, greener cars such as the Prius was part of the Obama economic platform.

The longer-term problems will remain, such as cleaning out the Augean stables of bank balance sheets – and the time has surely come for more radical action in that regard. But in the short term, there's no point in building a new factory if no one is buying cars.

Milton Friedman once wrote about using helicopters to drop cash on a population and provoke price rises. Time to polish up the rotors and rev the engines.

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