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Courtesy
of Calculated Risk here
are a pair of articles, one from Krugman and another from Greenspan on the
limits of debt.
That ’30s Feeling
Paul Krugman has That ’30s
Feeling
Suddenly,
creating jobs is out, inflicting pain is in. Condemning deficits and refusing
to help a still-struggling economy has become the new fashion everywhere,
including the United States, where 52 senators voted against extending aid to
the unemployed despite the highest rate of long-term joblessness since the
1930s.
Many economists, myself included, regard this turn to austerity as a huge
mistake. It raises memories of 1937, when F.D.R.’s premature attempt to
balance the budget helped plunge a recovering economy back into severe
recession. And here in Germany, a few scholars see parallels to the policies
of Heinrich Brüning, the chancellor from 1930 to 1932, whose devotion to
financial orthodoxy ended up sealing the doom of the Weimar Republic.
But despite these warnings, the deficit hawks are prevailing in most places
— and nowhere more than here, where the government has pledged 80
billion euros, almost $100 billion, in tax increases and spending cuts even
though the economy continues to operate far below capacity.
What’s the economic logic behind the government’s moves? The
answer, as far as I can tell, is that there isn’t any. ....
How bad will it be? Will it really be 1937 all over again? I don’t
know. What I do know is that economic policy around the world has taken a
major wrong turn, and that the odds of a prolonged slump are rising by the
day.
U.S.
Debt and the Greece Analogy
In sharp contrast to Krugman's position, Alan Greenspan compares the US to
Greece in U.S. Debt and the
Greece Analogy
An
urgency to rein in budget deficits seems to be gaining some traction among
American lawmakers. If so, it is none too soon. Perceptions of a large U.S.
borrowing capacity are misleading.
Despite the surge in federal debt to the public during the past 18
months—to $8.6 trillion from $5.5 trillion—inflation and
long-term interest rates, the typical symptoms of fiscal excess, have
remained remarkably subdued. This is regrettable, because it is fostering a
sense of complacency that can have dire consequences.
How much borrowing leeway at current interest rates remains for U.S. Treasury
financing is highly uncertain.
We cannot grow out of these fiscal pressures. The modest-sized post-baby-boom
labor force, if history is any guide, will not be able to consistently
increase output per hour by more than 3% annually. The product of a slowly
growing labor force and limited productivity growth will not provide the real
resources necessary to meet existing commitments.
Only politically toxic cuts or rationing of medical care, a marked rise in the
eligible age for health and retirement benefits, or significant inflation,
can close the deficit. I rule out large tax increases that would sap economic
growth (and the tax base) and accordingly achieve little added revenues.
It is little comfort that the dollar is still the least worst of the major
fiat currencies. But the inexorable rise in the price of gold indicates a
large number of investors are seeking a safe haven beyond fiat currencies.
The United States, and most of the rest of the developed world, is in need of
a tectonic shift in fiscal policy. Incremental change will not be adequate.
I do not believe that our lawmakers or others are aware of the degree of
impairment of our fiscal brakes. If we contained the amount of issuance of
Treasury securities, pressures on private capital markets would be eased.
Fortunately, the very severity of the pending crisis and growing analogies to
Greece set the stage for a serious response. That response needs to recognize
that the range of error of long-term U.S. budget forecasts (especially of
Medicare) is, in historic perspective, exceptionally wide. Our economy cannot
afford a major mistake in underestimating the corrosive momentum of this
fiscal crisis. Our policy focus must therefore err significantly on the side
of restraint.
There
is much more in the article including a discussion of interest rate swap
spreads which Greenspan says indicates upward pressure on 10-year treasury
yields.
Calculated Risk Weighs in with Krugman
I
believe Greenspan is flat wrong - just as he was in 2001 when he Greenspan
spoke of 'an on-budget surplus of almost $500 billion ... in fiscal year
2010'.
I believe the focus right now needs to be on jobs, jobs and jobs.
I Side with
Greenspan
Greenspan is seldom right and so is Krugman. In this case it is not even
close. Greenspan wins by a mile although he does miss a point when he states
"I believe the fears of budget contraction inducing a renewed decline
of economic activity are misplaced. The current spending momentum is so
pressing that it is highly unlikely that any politically feasible fiscal
constraint will unleash new deflationary forces."
Deflationary forces will be with us as long as we have this debt overhang and
I see no policy decisions to reduce that debt overhang at any level
(personal, corporate, municipal, state, federal).
Moreover, Japan has proven that countries can get away with reckless spending
for longer than most realize. However, that does not make Japan's policy a
wise on.
Japan now has debt to GDP of close to 200% and no realistic way of financing
it. Quite literally, high debt is all Japan has to show for Keynesian
stimulus that Krugman is arguing for. Japan simultaneously tried Monetarist
intervention and Quantitative Easing but that did nothing either.
Let's Play a Little Game of Q&A
Q. Do we need to stimulate housing?
A. No we have a glut of housing. We have massive shadow inventory on top of
that.
Q. Does housing typically lead every expansion out of recession?
A. Yes, it does. So we do not need to add to the housing glut.
Q. Do we need more commercial real estate?
A. No, and we do not need any more Pizza huts, Home Depots, Lowes,
Restaurants, strip malls, nail salons or any other such projects banks
normally lend to.
Q. Do we need more public workers at the city, state, or municipal level?
A. No, we surely do not. Public pension plans and public union salaries have
bankrupted cities, counties, and states. We need to get rid of public workers
and reduce benefit levels to match private sector.
Q. Do we need more roads programs?
A. Didn't we just try that? It did not work either, did it? All it produced
was a flurry of activity that died as soon as the handouts stopped. Just as
with housing, there is a limit to how much demand can be brought forward.
Q. Did we get our money's worth for those programs?
A. Absolutely not. Money was thrown around without regard to cost, instead
focusing on how quickly it could be spent. Much of the money was wasted.
Q. Are we going to "Drill Baby Drill"?
A. Hardly
Q. Does making schools and government buildings more energy efficient make
any sense?
A. Of course not. The expected payback on those programs is negative.
Challenge to Krugman and Calculated Risk
If you want jobs, name a jobs program that makes fiscal sense.
I suggest it cannot be done. Yes, demand can be brought forward, but only for
so long. Housing starts indicate housing is headed back to the gutter. Thus
those housing tax credits were a waste of money.
The problem is debt, at every level (personal, corporate, government). Worse
yet, that problem comes at a time when boomers have not saved enough for
retirement and pensions promises are coming to the forefront.
Rising taxes to pay for those public pensions is not the answer. Moreover,
students fresh out of college with no job and hundreds of thousands of
dollars in debt are delaying family formation, and family formation is one of
the keys to economic expansion.
Those clamoring for "jobs, jobs, jobs" never bother to explain what
happens when the stimulus runs out. It ran out in the 1930's as well. Krugman
mistakenly blames that small amount of tightening for sinking the US back
into deflation.
The reality is stimulus money always runs out and priming the pump is
nonsense. Japan has proven that in spades. What brought the US out of
deflation was WWII.
This may sound like the "broken window fallacy" and it is in
aggregate. However, the US was the one country that did not have its
productive capacity destroyed in the war, and that coupled with the start of
the baby boom, led the world recovery.
Those who claim we can grow our way out of debt now because we did it after
WWII fail to understand boomer dynamics. Baby boomers and their kids
supported growth for decades. Unless we have another baby boom it will not
happen again.
In fact, because of peak oil and because of consumer debt coupled with global
wage arbitrage, it's not possible to spend our way to prosperity this time,
even with another baby boom.
Besides, WWII was one hell of a price to pay. Let's all hope it does not take
war to solve the issue this time.
In the meantime, the problem is debt and as Japan has shown, and Greece after
that, with more countries like Spain waiting on deck, it is impossible to
spend one's way out of a debt problem.
Japan shows it is possible to get away with deficit spending for a long time,
but Greece clearly shows what happens when time runs out.
Fix the Structural Problems
Instead of "jobs programs" per se, we need to fix the structural
problems: Unsustainable pension promises and government wages, debt at every
level, corporate tax policies that encourage jobs to move overseas (deferral
of taxes on profits held overseas and excessive corporate taxes in the US),
and the entire tax and spend structure at every level, especially the public
level.
If we address the structural problems, jobs will eventually take care of
themselves.
Krugman is on the wrong side of this debate while Greenspan is mostly right.
However, no one will pay any heed to the now discredited Greenspan who
ironically was worshiped for all the things he got wrong and ignored the few
times he ever said anything that made any sense.
Mish
GlobalEconomicAnalysis.blogspot.com
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Thoughts
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