Why all stimulus packages fail

Here lies the fatal flaw of all fiscal stimulus packages - the long run interest rate.

Since it became clear that Obama wanted to pump up the US fiscal deficit to unprecedented levels, the yield on long term US government paper began to rise. Since late December, the 20 year, the constant maturity T-bill rate has increased 81 basis points. That is the equivalent of three rate hikes. However, Obama hasn't even begun to ratchet up the deficit. Imagine what will happen to rates when the Federal Reserve tries to shift $100 billion of debt every month.

What happens if the Fed holds a T-bill auction and no one turns up? Actually, the Fed has an answer to that question. The Fed will buy the debt directly and print lots of crisp dollar notes to cover the cost. Existing US government debt holders will recoil in horror as their investments are destroyed by a huge wave of newly printed cash.

Forward looking investors, ie the Chinese government, will move long before the Fed gets a chance to monetize the deficit. The Chinese will start selling their US treasury bills, pushing up long term yields and killing off any hope of an early US economic recovery.

And if you are thinking that none of this has anything to do with the UK, think again. Brown and Darling's plans for a fiscal stimulus are just as large and equally ill conceived.

The relationship between long term government yields and fiscal deficits is well understood. When government borrows and spends,it raises interest rates and kills off private sector investment. This is called crowding out.

The bond market is about to teach everyone that governments can not spend their way out of trouble. The question is whether Obama and Brown are sitting at their desks and paying attention to the teacher.