The immediate impact of the nearly one trillion dollar bailout of the U.S. financial sector by the Treasury Department is, hopefully, an end to short-selling speculation and a return to greater stability. The latter will find expression in banks being willing to lend to one another again, after a period of about a year when requests for loans were treated as toxic.

This will be positive for the economy in the short run and will get businesses and consumers back into a “spending frame of mind” as credit becomes more available and worthless mortgages are purged from the system. But what will be the ultimate price?

The United States, having never been through such a massive government bailout before, may well have to face up to some harsher long-term realities. Here is what would seem to be the most likely scenario. And by the way, this is what some other countries have gone through when faced with enormous government debt.

The U.S. government will be anxious to reduce its debt load as quickly as possible. Wouldn’t you be, if you were in the hole by about ten trillion dollars? It will be hard to resist having higher prices take care of part of the problem. This means a likely pickup in inflation caused by printing more money. More inflation means higher interest rates.

More inflation also means a worsening of the trade deficit. This may lead to additional downward pressure on the value of the U.S. dollar. The huge trade deficit already in place has required China and Japan to keep buying treasury bills at interest rates that are unappealingly low. How long can this last? Furthermore, there is already some talk of a possible downgrade of U.S. government securities from AAA status to a lesser ranking.

The greenback versus the Euro is likely to suffer further indignity. Higher inflation, a falling dollar and rising interest rates are a terrible trinity. Recession will be hard to avoid. Policy makers might well be advised to ask what measures an international agency such as the World Bank or International Monetary Fund would require of a delinquent nation when its finances go into arrears.

Alex Carrick

Find Canadian construction-related economic articles in Canadian Construction Market News and in the Economic Outlook section of Daily Commercial News.

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