The world’s
rich countries are now conducting a dangerous experiment. They are
repeating an economic policy out of the 1930s — starting to cut
spending and raise taxes before a recovery is assured — and hoping
today’s situation is different enough to assure a different outcome.
In effect, policy makers are betting
that the private sector can make up for the withdrawal of stimulus
over the next couple of years. If they’re right, they will have made a
head start on closing their enormous budget deficits. If they’re
wrong, they may set off a vicious new cycle, in which public spending
cuts weaken the world economy and beget new private spending cuts.
On Tuesday, pessimism seemed the better bet. Stocks fell around the
world, over worries about economic growth.
Longer term,
though, it’s still impossible to know which prediction will turn out
to be right. You can find good evidence to support either one.
The private sector in many rich countries has continued to grow at a
fairly good clip in recent months. In the United States, wages, total
hours worked, industrial production and corporate profits have
all risen significantly. And unlike in the 1930s, developing
countries are now big enough that their growth can lift other
countries’ economies.
On the other hand, the most recent
economic numbers have offered some reason for worry, and the coming
fiscal tightening in this country won’t be much smaller than the 1930s
version. From 1936 to 1938, when the Roosevelt administration
believed that the Great Depression
was largely over, tax increases and spending declines combined to equal
5 percent of gross domestic product.
Back then, however, European governments were raising their
spending in the run-up to World War II. This time, almost the entire
world will be withdrawing its stimulus at once. From 2009 to 2011,
the tightening in the United States will equal 4.6 percent of G.D.P.,
according to the International Monetary Fund.
In Britain, even before taking into account the recently announced
budget cuts, it was set to equal 2.5 percent.
Worldwide, it will equal a
little more than 2 percent of total output.
Today, no wealthy
country is an obvious candidate to be the world’s growth engine, and
the simultaneous moves have the potential to unnerve consumers,
businesses and investors, says Adam Posen, an American expert on
financial crises now working for the Bank of
England. “The world may be making a mistake, and it may turn out
to make things worse rather than better,” Mr. Posen said.
But
he added — after mentioning China, India and the relative health of
the financial system, today versus the 1930s — that, “The chances
we’re going to come out of this O.K. are still larger than the chances
that we aren’t.”
•
The policy mistakes of the 1930s
stemmed mostly from ignorance. John Maynard
Keynes was still a practicing economist in those days, and his
central insight about depressions — that governments need to spend
when the private sector isn’t — was not widely understood. In the
1932 presidential campaign, Franklin D.
Roosevelt vowed to outdo Herbert Hoover
by balancing the budget. Much of Europe was also tightening at the
time.
If anything, the initial stages of our own recent crisis
were more severe than the Great Depression. Global trade, industrial
production and stocks all dropped more in 2008-9 than in 1929-30, as
a study by Barry Eichengreen and Kevin H. O’Rourke found.
In 2008, though, policy makers in most countries knew to act
aggressively. The Federal Reserve and
other central banks flooded the world with cheap money. The United
States, China, Japan and, to a lesser extent, Europe, increased
spending and cut taxes.
It worked. By early last year, within
six months of the collapse of Lehman Brothers,
economies were starting to recover.
The recovery has continued
this year, and it has the potential to create a virtuous cycle. Higher
profits and incomes can lead to more spending — and yet higher
profits and incomes. Government stimulus, in that case, would no longer
be necessary.
An internal memo from White House economists to
other senior aides last week noted that policy makers “necessarily
tend to focus on the impediments to recovery.” But, the memo argued,
the economy’s strengths, like exports and manufacturing, “more than
make up for continued areas of weakness, like housing and commercial
real estate.”
That optimistic take, however, is more debatable
today than it would have been a month or two ago.
As is often the case after a financial crisis, this recovery is turning out to be a
choppy one. Companies kept increasing pay and hours last month, for
example, but did little new hiring. On Tuesday, the Conference Board reported that consumer confidence fell
sharply this month.
And just as households and
businesses are becoming skittish, governments are getting ready to let
stimulus programs expire, the equivalent of cutting spending and
raising taxes. The Senate has so far refused to pass a bill that would
extend unemployment insurance or send aid to ailing state
governments. Goldman Sachs economists this
week described the Senate’s inaction as “an increasingly important
risk to growth.”
The parallels to 1937 are not reassuring. From
1933 to 1937, the United States economy expanded more than 40
percent, even surpassing its 1929 high. But the recovery was still not
durable enough to survive Roosevelt’s spending cuts and new Social Security tax. In 1938, the
economy shrank 3.4 percent, and unemployment spiked.
Given
this history, why would policy makers want to put on another fiscal
hair shirt today?
The reasons vary by country. Greece has no
choice. It is out of money, and the markets will not lend to it at a
reasonable rate. Several other countries are worried — not ludicrously
— that financial markets may turn on them, too, if they delay
deficit reduction. Spain falls into this category, and even Britain
may.
Then there are the
countries that still have the cash or borrowing ability to push for
more growth, like the United States, Germany and China, which happen to
be three of the world’s biggest economies. Yet they are also
reluctant.
China, until recently at least, has been
worried about its housing market overheating. Germany has long been
afraid of stimulus, because of inflation’s role in the Nazis’
political rise. In responding to the recent financial crisis, Europe,
led by Germany, was much more timid than the United States, which is
one reason the European economy is in worse shape today.
The reasons for the new American austerity
are subtler, but not shocking. Our economy remains in rough shape, by
any measure. So it’s easy to confuse its condition (bad) with its
direction (better) and to lose sight of how
much worse it could be. The
unyielding criticism from those who opposed stimulus from the get-go —
laissez-faire economists, Congressional Republicans, German leaders —
plays a role, too. They’re able to shout louder than the data.
Finally, the idea that the world’s rich countries need to cut spending
and raise taxes has a lot of truth
to it. The United States, Europe and Japan have all made promises
they cannot afford. Eventually, something needs to change.
In
an ideal world, countries would pair more short-term spending and tax
cuts with long-term spending cuts and tax increases. But not a single
big country has figured out, politically, how to do that.
Instead, we are left to hope that we have absorbed just enough of the
1930s lesson.
The
violence that occurred during the recent G20 summit in Toronto and the
focus on the $1-billion cost of the affair overshadowed what was
surely the most critical element of the meeting of world leaders: how
to prevent, or at least best deal with, the continuing grave economic
problems that beset almost all of the G20 countries save Canada.
Many Canadians, most of whom kept their jobs in the short,
sharp recession that ended one year ago, may understandably be
blissfully unaware of the pressing economic problems many other
countries yet face as they struggle to reemerge from their recessions,
or worse, to avoid a slip back into another recession.
They
should be more aware and governments should also be careful whose
advice they take. This past week, in a piece entitled The Third
Depression, Nobel Prize-winning economist Paul Krugman even wrote of
the possibility of a third Great Depression, noting that while
recessions occur regularly, he feared that much of the world was
entering a Long Depression akin to the one that occurred following the
1873 panic in stock markets, which was followed by years of instability
and deflation.
Krugman's remedy --
governments should spend, spend, spend to prevent deflation -- is not
one with which we agree. Krugman's Nobel Prize is admirable, but other
Nobel economists also exist and they disagree with Krugman. Canada's
Robert Mundell, a Nobel Prize winner himself, recently advised the
American government to lower business tax rates to spur reinvestment and
recapitalize American banks.
U.S. room to move on tax rates, or
much of anything else, is severely limited by how much Washington has
already spent.
The U.S. public and Congress seem to have soured as
of late on any new "stimulus" measures, this perhaps because the last
round of deficit-increasing trillion-dollar stimulus packages, from the
last administration and the new one, did not, as current U.S.
President Barack Obama hoped, lower U.S. unemployment.
Instead,
much of the money spent on bailouts, temporary tax rebates,
cash-for-clunkers for automobile purchases and $8,000 tax credits for
home purchases, merely stole purchases from the future and into the
past 12 to 18 months. The result has been weakened consumer spending as
of late. So the United States is back to where it started with an even
bigger debt.
That, along with similar problems in Europe, is why
the Krugmans of the world are incorrect to urge governments to spend
more. Moreover, just this week, the Genevabased Bank of International
Settlements stated that, "The first and most immediate challenge is to
make a convincing start on reducing budget deficits in the advanced
economies."
Private-sector confidence
has steadily eroded as governments have borrowed more. Governments that
excessively borrow crowd out the private sector and the private sector
knows it, which is why companies are reluctant to spend on capital
investment and new employees.
Europe is awash in red ink; the
U.S. is mired in federal and state debt and a massive housing
over-supply four years after prices first began to decline, and China's
overheated property market may also soon burst causing more economic
problems for the world. The situation worldwide calls for governments to
be careful in their spending, not to assume they can finance another
stimulus with questionable results.
Japan has been in what amounts
to a "long recession "since the early 1990s -- and it followed
Krugman's advice. At present, we think it more sensible for other
nations to follow Canada's lead, our own Nobel-winning economist, and
finally allow the private sector ultimately and finally to pull the
world out of its economic malaise.
I’ve
been taking a bit of a trip down memory lane, looking at older blog
posts in aid of a possible future project. And I was struck by
something I sort of knew, but hadn’t focused on: the latest round of
oh-my-God-the-bond-vigilantes-are-attacking-gotta-cut is the third such
round since Obama took office.
First, there was a runup in
interest rates in the spring of 2009 — mainly a reaction to receding
fears of a second Great Depression, but widely interpreted as a sign of
impending fiscal doom. Then rates went back down.
Second, there
was a big scare in the fall of 2009, based on, well, nothing — which
is what led me to write my original post on invisible
bond vigilantes. And fear of this phantom
menace helped scare the Obama administration away from a second
stimulus.
Finally, there was the bond scare of March, in which we
were turning into Greece because of a blip in rates barely visible on
the charts. Since then, rates have plunged.
It kind of makes you
wonder: why do such claims carry any credibility? Bear in mind, too,
that anyone who actually acted on these deficit scares — who, for
example, believed Morgan
Stanley’s prediction of soaring rates in 2010 — has lost a lot of
money.
But I have a sinking feeling that the next time long
rates rise even a bit — say, back to where they were a year ago — we’ll
be told that the bond vigilantes have arrived. Really. And Washington
will believe it.
And rates can rise from these
levels, especially if economic data comes in stronger than expected.
Consider this, Bloomberg reports that Treasury
Two-Year Yield Drops to Record Low on Slowdown Concern:
Treasuries
rallied, pushing the two- year note yield to an all-time low, as U.S.
companies added fewer jobs in June than economists forecast and China’s
manufacturing growth slowed.
The extra yield
investors demand to hold 10-year notes over 2-year debt dropped the
most in six weeks on heightened deflation concern. The U.S. government
will sell $12 billion in 10-year Treasury Inflation Protected
Securities on July 8.
“Whoever is calling for a double dip is
emboldened by this week,” said Suvrat Prakash, an interest-rate
strategist in New York at BNP Paribas SA, one of the 18 primary dealers
obligated to participate in Treasury auctions. “We have to be a little
more cautious about what we expect in the future.”
The yield on the 10-year note dropped this week by
13 basis points, or 0.13 percentage point, to 2.98 percent, according
to BGCantor Market Data. The price of the 3.5 percent security maturing
in May 2020 increased 1 1/8, or $11.25 per $1,000 face amount, to 104
13/32.
The benchmark note’s yield fell the
most since the five days ended May 21, when it dropped 22 basis points.
It touched 2.88 percent on July 1, the lowest level since April 28,
2009. The two-year note yield slid 3 basis points to 0.62 percent after
reaching the all-time low of 0.5856 percent on June 30.
The difference between 10- and 2-year note debt,
known as the yield curve, dropped this week to 2.36 percentage points
after touching 2.28 percentage points on July 1, the lowest level since
Oct. 2.
The narrowed spread indicates
investor preference for longer-term bonds, which tend to rise on
slowing inflation. Two- year rates tend to track the outlook for the
Fed’s target rate for overnight lending.
“Bonds are saying this economy is getting bad,” said Michael Franzese,
managing director and head of Treasury trading at Wunderlich Securities
Inc. in New York. “People are going across the curve. They are buying
for yield and capital preservation.”
My feeling is that the curve flattener trade is getting
overcrowded, and yields can easily snap back from these levels,
especially if economic data comes in stronger than expected.
But maybe the bond market is worried that austerity
measures will effectively kill the fragile economic recovery, pitching
the world into a protracted period of deflation. With 10- and 30-year
yields plummeting
to their lowest level since April 2009, there sure seems to be an
ominous 1930s echo in the air.
Vintage pro-inflation propaganda 1930's video. IMHO well worth watching to see how the US government lies to the public. And nearly a century later they are still trying to jabber jaw the lies, yet now the US government uses MSM.
www.popmodal.com/video/2066/Vintage-pro-inflation-propaganda
I'm no financial wizard like a lot of you, but a lot of this seems recycled talking points from Limbaugh. Sure the government wastes money, that's what governments do. And of course Friedman was right about "the 4 ways to spend money", but it's not black and white. Atlas Shrugged was a fun book and that's it. It wouldn't work. We like to point the finger at Europe and laugh that their excessive care for their citizens has bankrupted them, but the last 2 generations of Europeans have lived a much higher quality of life than we have, and it could well be argued that their attraction to our "no-money down" system is what did them in. They weren't rich enough to handle it. Neither are we really. The point I'm reaching (maybe far-reaching) for is that social democracies can function effectively if vetted for corruption. The free market alone creates a vacuum to the wealthy that needs to be reset when the bag gets full. Feel free to fire away, but my years living in Europe vs USA left me a fairly distinct understanding of the differences. Live well in Europe not making a lot of money, or work like a dog in the US to try and get rich. I chose the latter, but when I'm done....
http://www.escapefromamerica.com/2010/06/escape-from-america-the-grim-tr...
Hey BK
Thanks for pointing out that Mr.Rush-to-Judgement steals (some) of his ideas from Zerohedge. Original thinking is outside Limbaugh's reach.
US in the 50s and 60s was more like Europe, we had flat incomes, kinda classless because manufacturer workers with HS degree could make nearly as much as highly eduction professionals...even in 70s in my white working class neighborhood had everyone from school janitor to director of chemistry lab living in same area, similar houses.
Now illegal immigrants working service jobs compared to MBA at a big corp...not even in same world.
I don't see how Europes policies have been better or worse than US in terms of end financial result, we both have too much debt, but at least Europe's regular working folks got something for it.
Bond vigilantes are not a 'phantom'.
Yes, the game can be carried on longer than most people thought ... But if one waits till the bond market pukes to have 'proof' there's a problem, it's too late.
And even funnelling Ben Bernanke's fiatscos through the Cayman Islands to buy gov't securities, can't work forever.
"I'm not sure that Leo appreciates the lack of fundamentals behind
today's 'recovery'"
The fundamentals are:
1) prop up TBTF banks, they can then purchase regional banks and
get bigger
2) prop up failing industries done in by unions so that union retirees
continue to get pensions and health care
3) prop up local, state, federal gov't jobs
4) pay for all of it with increasingly confiscatory taxes on workers and
burden their children with future debt to boot
"Industries done in by unions"? To take but one example, the unions did not keep the big three from making decent cars during the voluntary restraint agreement days of the 1980s. Among many other things, US industries were done in by management moving jobs offshore.
Seems to me you are missing the biggest culprit of all in your list: Management. Why don't you ask what management's role is/was in creating today's mess? Let's blame everyone but the ones responsible. Sorry to be harsh, but...
Though I'm sure Andy Grove has his issues, the ideas in this piece seem to me to have merit:
http://www.bloomberg.com/news/2010-07-01/how-to-make-an-american-job-bef...
Get real! The Big 3 cars in the '80s absolutely SUCKED! They were HORRIBLE! I still would not buy a Chrysler and I would only think about a GM. Only now would actually consider buying a Ford.
The Big 3 need to be set loose to fail so that new auto companies that actually make a quality product with excellent design can rise in their place.
My point exactly, management did not use the breathing space created by the voluntary restraint agreements to improve car quality. Don't blame the unions for management's management failures.
Gentlemen
It was BOTH union and management that destroyed the American car business.
+ Big 3
The GM H-body and W-body platforms of the mid-late 1980s are still the basis of most of GM's modern cars. Reliability-wise, they're on-par, if not better than their foreign counterparts. And fuel-consumption-wise, GM's cars of the late 1980s are still just as good as the stuff being sold today by the Japanese or European vendors, more or less.
Right. The market bears that out completely. That's why we continue to see declining market share from the Big 3. Everyone is just rushing to buy all those "cheap" Japanese imports for their poor quality, low reliability, and stodgy design.
Right...we are in a national-chrysalis stage - Forming an unrecognizable new society from the sluffed exoskeleton of the old. How better to dictate heretofore unconscionable new societal rules than to reduce the (almost) entire population unable to afford to feed their families.
Break the machinery until nothing works and use societal panic as a catalyst to metamorphosis.
Maybe I've just been watching too much Nick-Jr. lately... :)
The reason why Treasuries are rallying is simple; the biggest buyer of all, the market maker is making a market. Central banks love to re-purchase government bonds.
Is it really that hard to work out Leo?
I'm not sure that Leo appreciates the lack of fundamentals behind today's 'recovery', the can-kicking, the opacity, the robbing peter to pay paul, the front running, the dodgy financial instruments that are swallowing traditional capital. 'Confidence' cannot run on fumes alone.
The shadows of todays capitalists are far taller than the capitalists. and when shadows are at their tallest - you know it's approaching sunset.
The scarcest of all the fundamentals is TRUST and I don't know how that is ever coming back in the near future.
ZIRP has produced ZIP (JR). And more ZIRP will produce more ZIP. Japan (which funds its own federal debt) has had a ZIRP policy for 20 years; let (spend everyone else's money) Krugman explain why 20 years of zero cost debt hasn't turned Japan back to an economic Tiger.
A national jobs policy of INSOURCING lost American jobs could be a start, by ELIMINATING payroll taxes on MANUFACTURING.
And a confiscatory container tax at port of entry- no matter how much squealing and blather we hear from Warren and Chinese Walmart.
Re: The shadows of todays capitalists are far taller than the capitalists. and when shadows are at their tallest - you know it's approaching sunset.
HA! Good one. Worth of stealing!
+1
Excellent.
Leo - what's your point? No really, what idea are you trying to inform the reader of? You pasted one article suggesting more stimulus spending is needed, and then counter with a different argument. And then add in a seemingly off-topic comment about the yield flattener trade and how yields can rise if eco data comes in better than expected (but wasn't the point earlier that less gov spending will lead to lower economic activity?).
As I commented in your other article, I love to see counter-discussion on ZH but please add a unique insight backed up by fact, information, etc. I can get the cut and paste on the MSM, thank you.
One last comment, the NYT quote seems to buy hook-line-sinker the idea that economics is a science and that Keynes' arguments are more than theories. IMO this sort of macro-economics is more certainly not a science and we are doing nothing more than experimenting, with politicians (and the MSM) choosing to believe in actions that are self-serving (spending to get re-elected).
The point is maybe the bond market is worried that the price of austerity will be deflation. What else can explain the yields falling to April '09 levels?
Leo, thanks for responding to my question. I'm not an English Professor (just a blogger, so what do I know?), but if that was your point, the yield curve flattener over-crowded comment at the end was a bit distracting to the reader (me anyway) and muddled your point.
Personally, I think the bond market is essentially manipulated at this point, so I have a hard time drawing conclusions on its performance. At the very least, the Fed has provided EVERY incentive for banks to not loan money to businesses (who can blame them) but to buy bonds and leverage up, up, up to earn back the holes in their balance sheets with the spread (on the backs of savers). The Feds have essentially crowded out all private borrowing. I also think there is a mis-placed flight to the liquidity of t-bonds (which I think will be proved wrong over the long term) as the market senses things might be getting much worse soon. It will be interesting to see when and how the global circle-jerk will end.
Please come to the UK and explain to Sainsbury's that we experience a deflationary environment. They have yanked up my groceries bill by 12% over the past year.
For all the rhetoric going in the direction of deflation, the fact remains that deficit spending kicked off hyperinflation in Germany.
Leo, real estate (both residential and commercial) became a can't lose flipping game based on easy money not necessarily tied to the ability of the buyer to repay. The major factor in the coming deflationary period is because the music stopped in the flipping game. But, it was just a game so the deflation is simply the market reverting to a historical norm. That bankers, insurers, pensions funds all bought trash (and most have zero equity if marked to market) is deflationary and not just needed but unavoidable unless Krugman buys every piece of real estate at the "inflated" price..
Feel that is true.
But tell me at some point this (austerity) needs to happen given the amount of debt ..
The problem is most countries seem to be highly indebted ..
So which is better .. take the bitter pill now when debts are lower OR take it later when the debts are heavier.
Krugman's point seems to be that growth will take care of the heavier debt ... but what are the odds and what happens if that(growth) does not happen ..
A quick painful end is better than pain without end. This also holds true for relationships.
The whole basis of Kugman's thinking is that we can re-ignite our economic engine ... but what he fails to address is that our economic engine was consumption and debt creation; hardly things that we want to re-ignite. 1992-2001 = techno explosion; 2001-2008 = debt explosion. 1992-2008 = production depression, crumbling manufacturing, and explosive derivative (financial leverage) growth. We have exchanged guns and butter for smoke and mirrors.
What do we do to get out of the hole we made for ourselves?
Exactly. I saw Krugman on a couple of the weekend shows. He just wants to spend more, and worry about the long-term later. What I never heard him (or anyone else) mention is that the economic problems might be structural and not cyclical. So perhaps one could argue for money to be spent to fix structural problems (a corporate restructuring if you will), instead of just propping up the economy for just a little bit longer (and not acknowledging what happens when that next stimulus runs out).
Structural and cultural ... During the Great Depression, Americans had an ethical attitude that said 'I would rather starve than steal'. It would seem that this cultural imperative has been trumped by a Post Modern reality that 'the Good' can be defined by the individual. So how do we get out of this cultural morass?
During the Great Depression, Americans kept reproducing and our population kept rising (a rising tide does lift most boats). Our population is now shrinking ... not just due to a Baby Boom generation retiring, but a generation who place very little value on marriage (except gay marriage), and even less emphasis on having children. How do we pull ourselves up by our bootstraps if we have declining and failing bootstraps?
Questions abound but answers? Where are the answers?
+alot
What do we do to get out of the hole we made for ourselves?
Great question!!! Wish there was someone in power in this country right now asking it. The time we are wasting digging ourselves deeper and deeper is just F*&%ing tragic.
Leo, the the bond market is worried that the price of austerity will be deflation of what they own. They could give a shit that food and gas are increasing in price at the same time.
If they mispriced the risk when they bought it, it must suck to be them. This is no reason for the majority of us to bankrupt ourselves for their benefit.
For that matter, rates are at multi-year lows and they can sell the shit. Oh, they need more buyers to get a higher price? And only hopium will provide that? Hardly our problem.
Re: The point is maybe the bond market is worried that the price of austerity will be deflation
Sounds like the only possible result of "austerity". I'd be depressed too if I were the bond market and knew that a significant amount of my market was total fantasy. Of course, that's the entire point of a depression. To work the pollyanna optimism out of the population. 40 years of hopium is enough for any society.
40 years of "hopium"....
Hope in one hand, Leo in the other. Rub them together, see what you get.
One thing to keep in mind during the 1930s depression was that the dollar was backed by gold, and US government bonds were also backed by gold. So the stock recovery of the early 1930s, in gold terms, was extremely powerful.
Another thing I didn't know - between 1937 until 1941 an amount of gold equal to the US M0 money supply fled Europe to the US ahead of the war. Sort of squinting at the chart for the monetary base, that would be the equivalent of about 1.6 trillion in gold now.
That should've been hugely inflationary, yet it wasn't. This speaks to the power of the deflationary forces at work in the 30s.
also speaks to what got us our of depression...they say it was WWII...but what does that mean....govt spending and demand?, isn't that Keynesianism for tanks rather than roads?....I think it had to do with us being the safe developed country, worldwide investment came to us, etc..
Again, the world war II turnaround was about individual motivations, not macro forces. Individuals wanted to win the war. "Patriotism" they used to call it. And it generated long working hours, victory gardens, toleration of confiscatory taxes and rationing, and resolve to win, all hands on deck.
Without this war, the depression would have continued, again, thanks to government incentivizing what you want less of(sloth and waste), and disincentivizing what you want maximized(work and investment).
It's all about why individuals do what they do. Anyone know John Galt?
Individuals wanting to win the war?
I read a study years ago about the behaviour of the common US infantry trooper.
Showed time was spent more on dodging bullets and ducking behind cover than aiming weapons at the other side.
Wars between states usually rely on states as the names could imply.