Question: "I work for Lithia Motors, and I have to tell you am pretty scared as to what will happen to the big 3, we have already downsized quite a bit and so I guess my question is: John what do you think will happen and how bad could it possibly get? It is so hard to figure out this mess." --karensp9

Question: "Are you economically savvy enough to answer this question?

Is it possible that all the crazy government deficit spending may actually work to stabilize the economy this time, unlike the "Great Depression"?

It seems to me that our Federal government is intentionally putting inflationary pressure into the system by overspending and devaluing the dollar in order to off-set the natural deflationary pressure that an economic down-turn creates.

While not stopping the down-turn, is it possible they will soften it by this crazy inflationary monetary policy?" -- canddmf

Answer: First off, "how bad could it possibly get?" My best guess is that it's going to get significantly worse than it is today. It's very likely that a lot more big corporations and small businesses are going to go belly up, the unemployment rate is going to skyrocket, deficits are going to spike, and it's not entirely out of the question that this could turn out to be some sort of negative tipping point for our economy. I have actually considered taking a significant sized chunk of cash out of the bank and hiding it in the house, just in case we get to the point where there's a run on the local bank. So far, I haven't gone that route, but I know some extremely smart people who've already done that.

As to the Big 3 in particular, my best guess is that Bush will punt by giving them enough money to make it through until Obama gets in the White House. Then, Obama and the Democrats will end up giving them an absolutely ridiculous sum so that the unions don't have to make any sort of serious effort to trim the fat. That would be foolish and unpopular, but the unions practically own the Democratic Party and with the numbers the Dems will have in Congress, it will be tough to stop. (Long term, the best thing for the country and the Big 3 would be bankruptcy, but that would be a disaster for the UAW.)

Now, could these predictions turn out to be completely wrong? Sure. Figuring out what the economy is going to do, especially in a fairly unique situation like this, is extraordinarily difficult. That's why opinions on how bad this is going to get and what the government should do to combat it are all over the map.

Personally, I think the worst thing we could do at a time like this would be to adopt some of the same failed policies that FDR used during the depression and that Japan used during the nineties.

What policies are those? Massive government spending, forced wage hikes, make work jobs, tariffs & trade barriers, and keeping alive zombie companies that can only survive with the help of the government.

Now, could enormous amounts of government spending help boost the economy? Well, there are certainly some very smart people who think so -- and they could be right -- to a certain extent at least. However, the government is inherently less efficient than the market, so government spending can never stimulate the economy as much as letting people keep more of their own money can. Moreover, I said "they could be right" about government spending significantly stimulating the economy. I'd say it's more likely that Arthur Laffer's line of reasoning in this area is spot-on,

As you read this, our government is committing enormous sums of money above and beyond normal spending, solely to stimulate the economy and prop up failing companies and markets. These additional sums are huge by any reasonable measure, with estimates as high as $3 trillion in an economy with a GDP of about $15 trillion.

Here's the bottom line: Instead of making things better, increased spending will only drive our economy further into the ground.

....It is true, as the proponents of these stimulus packages argue, that recipients of government checks will spend more than they otherwise would have spent. And, that increased spending will have a multiplier effect increasing spending even further. But this is only part of the story.

The government can only transfer resources; it can't create resources. There is no tooth fairy. Every dollar given to someone comes from someone else. The government can't bail some people out of trouble without putting other people into trouble, plus a hefty "toll for the troll."

In the case of last February's stimulus package, the government literally borrowed an extra $170 billion and at the same time sent out checks to the transfer recipients totaling $170 billion. The result was a $170 billion increase in the amount of bonds held by the public, accompanied by a $170 billion increase in the current value of future taxes to pay interest and principle on the additional debt.

From the standpoint of accounting, the government is $170 billion further in the red, and taxpayers are liable for an additional $170 billion worth of taxes. Therefore, for every dollar of transfer payment there's at least an equivalent dollar of future tax liabilities. Those people with the increased tax liabilities will spend less, thereby dis-employing people who had been supplying them with goods they'll no longer buy. And the reduction in spending of those with higher tax liabilities will lead to a multiplied reduction in total spending equal to and fully offsetting the increase in total spending from the recipients of government checks. There is no stimulus from the stimulus programs!

To see this point more intuitively, imagine what the "stimulus effect" would be if they borrowed the $700 billion from the same people to whom they gave the $700 billion and then promised to raise their taxes by enough in the future to pay off their bonds. Where's the stimulus in that?

At this point, we've already spent and set aside trillions and Paulson has said that the "major financial institutions (are) stabilized." Since that's the case, I think the government should deeply cut spending, forego the use of the next 350 billion dollars in TARP funds, get out of the bailout business, permanently renew the Bush tax cuts, and cut the corporate and capital gains tax. That would make for a nice next step. However, even if they did all of those things, we've probably still got a lot of economic pain coming down the pike.