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The Stimulus Package Explained by an MBA to a 3rd Grader **please Pass it On**

It’s kind of a point of pride for me that I am pretty good at taking complicated topics and breaking them down so everybody can understand them. So when I started looking at the stimulus package, I imagined having a conversation with a 10 y.o. about it. How would I explain it and what questions would they ask? So here’s the imaginary conversation with Timmy, a smart 10 year old 3rd grader with blue freckles. I know. I’m weird.

What is the stimulus package?

It’s a way for the government to inject money to help turn around a crappy economy. It does this by creating jobs, saving jobs, and ultimately getting people spending money again on things like cars, houses, investments, and Xbox’s.

Why do we need it?

1. Right now lots of people are out of work or don’t have enough work to pay their bills.
2. Because of that, they (consumers) can’t spend money buying stuff, investing, saving, or paying taxes.
3. Because consumers can’t buy stuff, businesses are not selling as much as they need to make a profit.
4. Because businesses aren’t making their profit, they are firing even more people. See point 1.
5. In addition, because people are not buying investments combined with business not making as much profits, that means the stock market is going down because the business stocks are not worth as much as the used to be.
6. When the stock market goes down, people lose money they had in there, can’t buy stuff, and stay away from putting any more money back in the stock market for a long time. On the business side, companies now don’t have the money it usually makes from selling stocks to invest in creating new stuff. Back to point 1 again.

How is the stimulus package supposed to fix it?

Create New Jobs -

What it means? More people working, more people paying taxes, more people buying stuff, which in turn means businesses hire more people to make more stuff, on and on. Upward Spiral.

How fast will it work? 1-5 years. Since most a lot of the spending is for infrastructure or big construction projects, it will be a while for that to trickle down. You don’t start a massive development project in a few weeks or even months. The upside is that these projects have a much greater return on investment over the long term. Lots of jobs for a long time to come. Just takes a little while to get started.

Save Existing Jobs-

What it means? State and Local governments are bumming. Because less people have jobs and spend less, states get less in taxes. Less in taxes mean that they have to cut programs and personnel. Less personell, more unemployment. Downward spiral.

How fast will it work? Immediate. These are existing jobs doing existing things. They can hire you back tomorrow if the government gives the local states and cities the funds. In addition, the workers will be then paying taxes on their income and buying more stuff. That’s helps everybody.

Provide Tax Relief

What it means? If you have more money in your pocket because you are paying less in taxes, you will spend more.

How fast will it work? Immediate to 1 year. This depends on what type of tax cuts they are. If they are employer tax cuts, you will see a difference in your paycheck right away. If they are credits or rebates on your year end taxes, you will not see any difference until you go to pay your taxes in 2010.

Another tough question as part of the tax relief – Will $20 more a week in your paycheck really do anything to increase your spending or consumer confidence? Will you even notice it? Also, I have a feeling that most people are not going to run out and buy a new big screen when they get their tax return next year. My guess is that they are going to use it to pay off their credit card debt, student loans, car payments, or mortgage balances they have been slacking on for the last year.

Making a better tomorrow

What it means? Many of the provisions in the stimulus package are towards energy independence, smart electricity grids, and education. These projects will also create a lot of jobs.

How fast will it work? 5-10 years minimum. These investment should all pay off handsomely, but they will take a long time. Energy independence and efficiency will eventually ease our reliance on outside energy and keep prices manageable (or at least insure that we buy from ourselves not foreign countries) Funding for education in theory will ensure that US keeps more jobs, increase US innovation, improve employment rate, and boost our GDP.

Helping those who are struggling

The last section of the stimulus package is to help out those in need. It’s a band-aid. Because so many people are unemployed right now, the y will be subsidizing health insurance and extending unemployment benefits.

How fast will it work? Immediately.

What caused the recession to start with?

To over-simplify: Greed and easy money. Banks lent money too easily in hopes of bigger profits, people spent too much on credit on stuff they really couldn’t afford, and business and people alike made risky investments in hopes of bigger profits. For a while banks were lending 95 to 100% loans. That means if you stop making payments, they take your asset (the thing you bought with the loan). If your asset loses any value (think housing market crash) then the banks are stuck owning something that is not worth as much money as you paid for it. Because they are stuck with this crap asset, they don’t have cash on hand to loan more money to other people. If the bank can’t make loans, they can’t make profits themselves (the interest they charge you for loan). End result – bank fail. Now combine that with people losing their jobs and shaky consumer confidence. As a result, consumers are not buying as many things that require a loan, and are not sticking money in the bank (which the bank then turns around and loans to other people) Vicious downward spiral.

Do other countries have stimulus packages?

Yup. China has its own stimulus packages that it unveiled last December. China said it would spend an estimated $586 billion over the next two years to construct new railways, subways and airports and to rebuild communities devastated by an earthquake in the southwest in May. As a percentage of Gross Domestic Product (how much money the entire country makes on stuff that it creates), Chinas bailout is actually bigger than ours.

Have we ever needed a stimulus package or were times this bad before?

Yup. Several Times. Most notably the Great Depression, which lasted from about 1929 to the early 1940′s. But there have been several other ones which were lot smaller and shorter.

Has a stimulus package worked before?

Yup. But what really helped wasn’t designed as a stimulus package exactly. Most economists say that the HUGE government investment in WWII is what finally pulled us out of the great depression. Teddy Roosevelt enacted a series of programs called the New Deal from about 1933-1939, and it started a slow upward tick from 1933 (when it was at rock bottom with 25% unemployment). But it was really when we committed to WWII and basically said, damn the price, we need these military supplies NOW that the country got to work building them. Because of the government spending on WWII we had a simply HUGE national deficit (10 times worse than it is now) as compared to our GDP. But, within about 4 years (between 1946 at its worst and 1950 at its best) not only was the deficit pulled out of the negative, but we actually had a surplus for one of the few times in US history. Thanks in large part to all these new business now paying taxes on all the money they made, people paying taxes on the income they made from these businesses, and people now buying stuff with improved consumer confidence and all the money they made.

Where is the money for the stimulus package going to come from?

That’s an excellent question. For 31 of the last 35 years, we have run a federal deficit. That means that the government takes in less than it spends. That’s like you having $5000 in bills a month and only making $3000 a month. That is not the same as the federal debt. The federal debt is money the government owes to its taxpayers or other countries. That’s like a credit card. You buy something now on credit and promise to pay it back later plus some additional fees for interest. Debt by itself is not necessarily a bad thing. But it IS a bad thing when you are running a deficit and have no real ways of fixing that deficit anytime soon. To help fund your deficit you take on more debt, when further increases your deficit. Get it? Now, how are we going to pay to dump this $800 billion into the economy when we already have $10.7 Trillion in debt, and still have a federal deficit of about $500 billion?

Option 1: We will get about 50% of the money from our Treasury selling securities to US consumers, businesses, and banks. The Treasury will sell T-Bills and bonds to us in exchange for an interest payment. They usually pay pretty crappy interest rates, but when the stock market is in such turmoil, a lot of people invest in them because they are very secure (The only time you will ever lose money on a Treasury Security is if the entire government crumbles, and if that is the case you got a LOT bigger problems than losing your money).

Demand for these securities will determine how much interest the Treasury has to pay to get buyers.

Option 2: We borrow money from other countries. That usually makes up about 30% percent of our debt (China is the big buyer these days)

Option 3: We still have about 20% of the funding to be taken care of. Where is that going to come from? Looks like nobody knows. Reassuring hunh?

What are the dangers of taking on this debt?

There are lots and lots. A few important ones tho…

Scenario 1: The demand for the Treasury Securities is really low. That means the Treasury has to offer really high interest rates to get people to buy them. This could cause 2 problems. First, banks have a limited amount of cash to invest. If it is more attractive for them to use peoples savings to buy Treasury Securities, than it is for them to loan money to people…they will buy the securities. That would have the opposite effect of helping the economy and would actually make things worse.

Scenario 2: Our big debt buyers like China are struggling too. They may not want to invest in our debt if they are having their own issues.

Scenario 3: If Americans don’t buy the debt, eventually other countries will step in. Can you anticipate what the problem would be if China or another country holds the majority of our debt? What if China decides it wants to become a bully? Imagine you mom lets the meanest bully at school hold everything you own…your bike, your lunch money, your toys? And the only way you can get them is if he says it is ok. That’s kind of what we are talking about here.

Could this really be another Great Depression?

It’s a real possibility. Not too many people are talking about it yet, but the similarities to the Great Depression are pretty scary. Most people think the Great Depression started from a few things…

Similarity 1:

Greed: An overindulgence on the part of consumers and the banks. After WWI, businesses had a surplus of inventories and introduced the idea of credit to help sell what they had. Because people were feeling pretty confident after winning the war, they went crazy buying stuff on credit. It was an decade of getting rich and enjoying new fads. Credit made it possible to buy what you couldn’t really afford.

Similarity 2:

Stock Market Crash of 1929: In the early 1920′s, because of the consumer confidence and huge amounts of money coming into businesses, it caused the first stock market bubble in the 10 years before the crash. Stock prices where unrealistically overinflated compared to their true value. Kind of like they have been for the last 10 years for us.

Then in 1928 or so because of the credit debt built up and other factors, consumer confidence was shaken and then finally failed. In October of 1929 on “Black Tuesday” the market suffered its biggest loss of $15 Billion in a single day (Think how much $15 Billion was in 1929 when a new car cost $250). A month later, the stock market had lost ALL of the gains it had made in the previous 2 years.

Similarity 3:

Bank Failure: Prior to the Great Depression, banks had made many loans to people, businesses, and other countries paying off THEIR war debts. They were also heavily invested in the stock market. As the recession took hold in the few years leading up to the great depression, more and more people defaulted on their loans, the stock market crashed and banks were in a position that they didn’t have the money on hand to allow people like you and me to withdraw funds from out own accounts. This caused a further panic which made EVERYBODY rush to the bank to take their money out only adding fuel to the fire. End result: Bank fail.

Is the Stimulus Package Going to Work?

I think so. I hope so. The similarities to the Great Depression and its causes are just too striking to believe that this well be over soon. But, I think we have a chance of getting out of it without going through something as severe as the Great Depression. Here’s Why:

Reason 1: The New Deal that Roosevelt enacted was very similar to the stimulus package we are talking about now BUT didn’t include nearly as much big spending. It’s showed some real signs of progress, but ultimately the huge investment in WWII pulled us out.

The new stimulus package has the big ticket spending built in from the get-go.

Reason 2: There is a lot of faith and confidence in Barak Obama. Since consumer confidence plays a huge role in a depression, having a trusted authority figure communicating with people on a frequent basis in a clear, honest way will really helps.

Reason 3: Hopefully we have learned a little from our years on the planet and the mistakes we have made in the past. I think we forgot about them for a while. A good slap in the head is always a useful reminder.

That’s it. Hoped this helped Timmy (and all of you). Let’s go play Xbox.

If you liked this article, and think it might be of help to anyone, please pass it on. Better yet, tell them to check out the EvilGeniusTV blog.

I say other smart stuff once in a while. As always please commment/critique/argue/flirt/yell/question below.

Don’t matter what it is.

 JJ

References used in this article: LOL. You ready for this?

Stimulus Package Unveiled – WSJ.com

America’s Great Depression – Causes and Cures

BEA Gross Domestic Product

BEA News Release U.S. International Trade in Goods and Services

Federal Budget Spending and the National Debt

Forbes.com – Magazine Article GDP Current Statistics – A Summary of Current US GDP Statistics

Great Depression – Wikipedia, the free encyclopedia

Gross domestic product – Wikipedia, the free encyclopedia

Just who owns the U.S. national debt – Answer desk- msnbc.com

News Analysis – Components of Stimulus Vary in Speed and Efficiency – NYTimes.com

The National Budget, Debt & Deficit MarkTAW.com

When Stock Prices Go Down, Where Does the Money Go

New Deal – Wikipedia, the free encyclopedia Great Depression in the United States – MSN Encarta

China Unveils Sweeping Plan for Economy – NYTimes.com

Who Will Fund Obama’s Stimulus Spending

 Digging Deeper Into Bull And Bear Markets

 Economic Stimulus Package Where does the money come from

**Links available at blog.

About the Author

JJ Kennedy is CEO of Evil Genius TV, the small business coaching and strategy arm of Evil Genius Interactive, a web and marketing development firm located in Gainesville, FL. He is an MBA, happily married to a Veteranarian, and is hoping to have a few little ones soon.

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