Guest Post: The Great American False Dilemma: Austerity vs. Stimulus

Tyler Durden's picture

Submitted by Chris Martenson contributing editor, Gregor Macdonald

The Great American False Dilemma: Austerity vs. Stimulus

“Like the issue of...’Is it better to have austerity or stimulus?’ Well, the basic problem there is that we’re not having a quality conversation on the subject.” --Ray Dalio, Bridgewater Associates, on the Charlie Rose program, October 20, 2011

Probably no American city better illustrates the trajectory of post-war US growth than Los Angeles. With its ganglion of highways (built when oil cost $14 dollars a barrel) and its never-ending boulevards that, having replaced vast acreages of citrus, now light up the night sky, the City of Angels spent 40 years blowing past its old pre-war borders and filled up an entire geological basin with infrastructure.

The scale of this expansion can be seen in this very helpful satellite photo from NASA, which captures a sweeping view of Los Angeles County. For example, Hollywood, a common reference point for most Americans, is reduced to a small village from this perspective; a mere data point, if you will, as the greater metro region cascades without interruption 100 miles to the east.

Even more awesome to contemplate is that much of this landscape is duplicated to the south, as well, through Orange and San Diego counties. Indeed, nearly 7% of US population lives in the five large counties of southern California, with counties like San Bernardino having exploded from 200,000 people after WW2 to over 2 million today. Unfortunately, what was long accepted as a triumph of growth the past 60 years has now become a rather burdensome and exceedingly expensive system to maintain.

I bring up the case of Los Angeles because there is currently a rather tribal, oppositional, and, of course, very heated debate taking place in the US right now that roughly frames the solution to our problems as a choice between Austerity and Stimulus. For this debate to have meaning, we need to consider how economic policies will actually solve the problems currently endured in a mega-region like Los Angeles. Unemployment, food stamp use, and energy costs have leapt ever higher here since the 2008 crisis. Moreover, the seeds of these trends were already showing up before the infamous Autumn of 2008. How would either a new phase of belt-tightening or reflationary policy actually affect southern California?

When we witness the clash between the Austerity and Stimulus camps, on the surface there is the appearance that a true debate is taking place between diametrically opposed economists. For example, Austerity folks correctly note that our economy has been badly weighted towards consumption for some decades. They want to clear out the excesses, let the malinvestments fail, and elect an overall path of acute economic pain in order to reset the system. Stimulus advocates find such plans completely unnecessary, if not downright masochistic. Armed with a more humanistic approach, Keynesians want the government to run large deficits to help the private sector deleverage, which of course could take years.

A late 2010 article in the FT by Gavyn Davies illustrates this point. From the viewpoint of sectoral balances, government deficits show up as “savings” on the balance sheet of the private sector. Of course, this is a deduced accounting identity and may not actually tell us much at all about whether the private sector is becoming healthier. I will probe further into this data later on in the essay. But first, the Gavyn Davies chart from the Financial Times: The most important graph of the year:

From the standpoint of a global macro economist, this is my nomination for the most important graph of the year. (See the end of this blog if you wish to suggest alternatives.) It explains why the world’s largest economy, the US, has defied the pessimists by mounting a decent recovery in 2010. It also explains the behavior of the government deficit and shows why it has so far been easy to finance this deficit.

This is the essential argument made by Keynesians and adherents to MMT (Modern Monetary Theory). The US is a monopoly issuer of its own currency, and while inflation is a risk, default (per se) is not. While interest rates are low during deleveraging in the developed markets (DM), why not ease social and economic pain through further borrowing? After all, as the chart implies, the private sector will simply use this spending to repair its own balance sheet. Once a tipping point is reached, then the private sector can start taking on new credit, increasing tax revenues to government, and thus knocking down the debt incurred during the recession (or depression). What’s not to like?

Meanwhile, a great example of the austerity argument comes from Ron Paul, who recently released his plan to dismantle several federal government agencies, end the wars, and consequently chop a full trillion out of the annual budget deficit. Those in favor of such fiscal shock and awe are also persuaded by the view that government spending “crowds out” the private sector, and that government misallocation of capital nearly always exceeds the private sector’s similar mistakes.

Frankly, I am sympathetic to the sincere urges on both sides of this debate. Why not conduct reflationary policy indefinitely, at least as a humanitarian exercise? That is the plea I detected in a recent Martin Wolf column, Time to Think the Unthinkable and Start Printing Again. And also, why not end the wars, kill off a number of regulatory agencies, and promote the growth of small business? Is it not clear that the Project of Empire has greatly deprived the US domestic economy of badly need infrastructure, transport, and educational investments?

Internal to this debate, however, are a number of shared assumptions about the free market’s ability to allocate resources---and the economy’s ability to create supply of those resources---given the proper encouragement from both policy and price signals. Namely, both sides are in near-complete agreement their prescription will not only deliver the US economy back to growth, but also to trend growth--an eventual rejoining, if you will, to the pre-2008 trend.

This is partly why this essay kicks off with a recent quote from Ray Dalio, founder of Bridgewater Associates, who correctly identifies that the situation we face is perhaps much more complex than can be solved by an entrenched, oppositional argument. Dalio is known for describing the economy as a machine that operates according to certain realities. I agree. Moreover, Dalio has also suggested repeatedly that once you understand how the machine operates, you no longer have to be so surprised all the time. Indeed, the last three years have been a true marvel, given how many people refuse to accept we are not in a post-war recession, but rather a debt-deflation depression. Do economists know how the economy actually operates?

As tough as I can be on the economics profession, I actually think most economists understand very well how the economy operates. But here is the problem: Their understanding has been rendered increasingly obsolete by the emerging problem of resource scarcity and the resistance of our built environment to an easy or quick energy transition. In other words, economists typically no longer have a solution for Los Angeles, or for Southern California. Or, for that matter, the United States. 

It’s quite clear that advocates on both sides of the current debate truly believe that the US can return to a growth path. Equally, they share an assumption that the supply of energy will adhere to a shift in the supply curve, which means simply that more supply or substitutes will be brought to market if the price level is sustained at high enough levels.

As the chart above shows, however, neither the steady advance of energy prices into 2008 nor the ensuing three years brought on new, usable energy sources that could reduce energy expenditures for Americans. But there is no mystery as to why Americans, having to spend more for energy and thus less on consumption and investment, have faced persistently high oil prices. We have a built environment that’s designed for liquid fossil fuels. And the expected shift in the supply curve for oil has not occurred.

Earlier this month in the Harvard Business Review, in our response to Dan Yergin’s faith in future oil supply and healthy, industrial economies, There Will Be Oil, But At What Price?, Chris Nelder and I wrote:

Yergin wants to have it both ways: He wants us to believe that the market will bear the high prices required to keep supply increasing against the backdrop of mature fields — which are declining by 5% per year — while at the same time asserting that prices will remain low enough to engender continued economic growth. This, we submit, is impossible.

A rather serious problem in the ability of Developed Economies to coherently allocate resources started showing up well before the 2008 crisis. This status quo, made in part by policy mistakes, credit creation, and the energy limit, still remains today. Crucially, neither stimulus nor austerity will dislodge this status quo. Unless, of course, by austerity we mean to intentionally collapse the system, or if by stimulus we mean to engender a runaway inflation that will eventually yield the same result.

Even if you agree that the US economy has gotten itself into a badly misaligned place, ripping one trillion dollars out of its center is hardly going to “free up” resources or immediately engage the private sector in replacement activity. Equally, throwing more trillions at the economy in its current condition may serve to heighten, not dampen, inequality. As we have seen already, while stimulus may have put a break on systemic collapse, it has likely perfected the status quo. I agree very much with Paul Brodsky’s remarks earlier this month in his essay On Media Coverage of the Protestors:

For those of you who self-identify as progressives, you should re-think your defense of the current system. Money printing is a terribly regressive tax on the working and middle classes. Those with higher incomes and access to credit remain able to maintain their demand for inelastic goods and services, as well as maintain their ability to service debts, while lower wage earners, those with less access to credit, and those losing jobs as the real economy shrinks, are suffering. For those of you who self-identify as “free-market conservatives”, you should also re-think your support of the current system. “Free markets” are compelled to de-leverage presently, not to re-leverage. A more laissez faire regulatory environment and lower taxes do not address the fundamental problem, which is an abundance of credit that re-distributes wealth from the factors of production to the leveragers.


In Part II: How The Coming Decline Will Play Out, I provide fresh data on California's economy and skewer the deductive accounting illusion that government deficits are allowing Americans to reduce their debts. I also show that free market failures are already occurring in the US economy. Austerity programs, from our current juncture, would do nothing but remove portions of the system at a time when the economy is not able to organically produce new economic flows. This would only serve to cripple the economy further, forcing it to contend with our crisis from an even lower starting point.

What the system needs instead is a more targeted transition process, not a radical simplification (Joseph Tainter’s term for collapse). Nevertheless, you can expect the sterile debate to continue, with the newest iteration of stimulus advocates now promoting NGDP (nominal GDP) Targeting. There is no question that capital markets, in the short term, absolutely love stimulus, because it allows existing economic flows to extend themselves temporarily. However, underneath this, all of the poor allocation of existing resources continues apace, and this is the central explanation for why the economy cannot create jobs: The connection between needs and actual production is badly broken.

Click here to access Part II of this report (free executive summary; enrollment required for full access).

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Ruffcut's picture

Real simple, austerity for main street and stimulus for wall street. Know your place in life, already.

Sheriff Douchenik from AZ's picture

Also known simply as QE1, QE2, QE666. etc

redpill's picture

The talk of "targeted transition" is unfortunately just too arrogant.  Even if you could get such a thing through Congress, which you couldn't without it becoming a bloated nightmare, it assumes that from a centralized standpoint you can properly guide the economy.  It's a fundamentally flawed assumption, and the harder you try the more distortions are made.

The win-win is cutting out portions of the government that are not aiding the private sector anyway.  Cutting need not equal austerity.  Coupled with a clearer, more certain, and lighter tax burden and a friendlier small business environment, it is the only way toward sustainable growth.

I know Martenson is big on the peak oil stuff, but the increase in energy expenditures is not the weight on our backs at this point.  It may be 3-5 years from now, but for the time being it is the dismal labor market and murky business conditions.

Leopold B. Scotch's picture

Why constantly dream up ways to recreate (ineffectively) what the market does naturally when allowed to be free of power / intervention collectivized in Big Government?  Each of these dreams creates a whole host of untoward problems which must then be solved, leading to more and more and more and more, etc.

A truly free market ain't perfect (nothing is), but it sure beats the interventionistas being in charge, and will bring more wealth to more people most rapidly vs. any alternative.  We continue to bankrupt ourselves believing interventionistas can fast forward that gaining of wealth.

Dr. Acula's picture

>Why constantly dream up ways to recreate (ineffectively) what the market does naturally

Because these enlightened individuals are smarter and more moral and warm-hearted than the greedy, callous entrepeneurs who compete and forecast and calculate and risk their fortunes every day to please their customers.

Most of us grasping cretins must adapt to market conditions, but these humble saviors of humanity are different. They are entitled to execute their well thought-out plans using other people's money and without having to face market disciplines.


dlmaniac's picture

If people overspend in the past then they'd have to either overproduce or underspend now to make it up. Austerity is simply Darwinism at work and mother nature enforcing common sense.

Stimulus is a foolish Keynesian attempt to mess with the law of nature. But what's your chance of survival when you go against Darwinism? It'd piss mother nature off so bad that she eventually comes in crushing that phony FIAT into zero. Austerity via hyperinflation, BITCHEZ!!!

Bought your physical gold and silver yet?

pemdas's picture

This is america.  We don't do austerity.  Before this is over we will make the Greeks look as stoic as North Koreans.

redpill's picture

We don't need to do austerity.  We have plenty of shit to cut before we'd ever need to be taking a bite out of granny's ss check.


Nigh Eve's picture

Sounds like wisdom from the Faux News Network.


LawsofPhysics's picture

"The US is a monopoly issuer of its own currency,"

I stopped right there.  Wrong.  The U.S. pays a private banking cartel to issue it's own currency.  Can't read past that lie, sorry.

CapitalistRock's picture

2/3 of US dollar creation happens in private banks through our fractional reserve banking system. The federal reserve does the rest. The US federal government does not manage any money creation.

LawsofPhysics's picture

To the sheep reading this article on zerohedge or elsewhere, the context of the statement in the article gave the impression that as a taxpayer you have some control over whether or not those banks or the fed print or not.  Total bullshit, you do not.  The printing is a fucking shell game that enriches fewer and fewer to the demise of everyone else, period.  So you essentially agree that the fractional reserve banking system is out of control.

Leopold B. Scotch's picture

Yep.  And the Congress the People elect is lead around by their wankers by the bankers, the majority of them bedfellows.  Without the Cartel, there is farrrrr lesssss power on the Potomac.

Dr. Acula's picture

But I thought the government is supposed to protect us defenseless consumers from evil monopolies and cartels taking our money.

For example, the DoJ is the one service provider to go to when you need help shutting down a monopoly that's competing unfairly with your business.

Now you're telling me the government actually helps form monopolies and cartels?

I'm shocked! SHOCKED!!!


Dr. Acula's picture

>The US federal government does not manage any money creation.

US Bureau of engraving & printing:

Federal reserve system:

 "Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled, That the short title of this Act shall be the "Federal Reserve Act.""


LawsofPhysics's picture

Exactly, our grandparents and great grandparents gave up the right to print our own currency a long time ago.  Expect the world to look like pakistan in the not so distant future.

Leopold B. Scotch's picture

That, ladies and gentlemen, is called Abdication of power... Although many in Congress gladly voted for it originally and allow it to continue so they may fund Government without having to directly raise taxes at the ballot box.   Inflation (aka classic money printing and credit from thin air) is a, among many things, a tax benefiting both big government and the oligarchy... It is a tax which not one man in a million is able to diagnose.

BigJim's picture

I was going to write:

      True. But to be fair, he's talking about the US's ability to avoid outright default via debt monetisation

...when I remembered that all new money is issued as debt. D'oh!

bob_dabolina's picture

Anyone looking at 3m libor?

Lower Class Elite's picture

No, but I am looking at 7.62mm FMJ...

mainuh1's picture

We've been warned since the early '70s that population growth versus resources would come to a head early in the 21st century. We ignored the warnings and stood by impotently watching economies collapse. Maybe we should have paid more attention in college instead of getting high.

SheepDog-One's picture

Nah, I vote for getting high. Doubles for me please.

Leopold B. Scotch's picture

The dip-wads among my college professors generally provided me with nothing but useless "in the box" material, turning out brainwashed automatons.  In hindsight I should have smoked a whole hell of a lot more.

What I learned about the shit going down the last decade I taught myself through my own efforts, and with the contribution of sites like this.

JR's picture


What high school or college teacher would have told us that the coming open borders concept would over shadow all of the population control adherence and magnify U.S. unemployment, prison and crime expenses, education costs,  welfare and subsidized and subprime housing?

Los Angeles County, California: Population 9,818,605. California population, 37,253,956.

Persons of Hispanic or Latino origin in Los Angeles County, 2010: 47.7%

White persons in Los Angeles County not Hispanic: 27.8%.

Foreign born persons Los Angeles County 2005-2009: 35.4%.

Language other than English spoken at home in Los Angeles County, pct age 5+, 2005-2009: 56.1%. In California: 42.2%.

Information from U.S. Census Bureau.


moneymutt's picture

our cities, our factories, our houses are designed for cheap energy, transitioning will be expensive, but we can live a decent life-style consuming far far less energy and far less difficult to grow, water intensive food, livestock, so even if new, cheaper alternatives are not found, while something like meat might be expensive and Cali may not be able to afford to grow rice in a desert, we could still do quite well. Most of our problems will be solvable, but likely will not be solved well because short sightedness of our politics and our markets

blunderdog's picture

Energy-wise, cities tend to be significantly more efficient than suburban/rural population distributions, but come on.  You really think you're going to get 150,000,000 people who hate each other to move to the same neighborhoods?


TheSilverJournal's picture

The clearing of the malinvestments is imminent. Either QE is stopped, exposing the malinvestments and depositors are allowed to lose their money, leaving physical cash to maintain some value, or QE is continually increased, keeping the malinvestments from becoming exposed, until hyperinflation hits. Hyperinflation is completely economically devastating and Americans will become much poorer. With hyperinflation, the US will no longer be able to benefit from the printing press and will no longer be able to support housing through cheap credit. All in all, housing will crash 70%-80%. On the other hand, gold will hit min. $10,000 in real terms and the silver to gold ratio will hit min. 10 to 1, meaning silver will hit $1,000 which is a near 3,000% gain..SO..Sell your house and buy silver before everyone else does.

Ruffcut's picture

If I sell my house, where do I store my silver?  I can't live in silver, nor eat it. I took a bite and broke a tooth.

TheSilverJournal's picture

Rent. It's cheaper than a mortgage, you don't own a depreciating asset, and you don't have to be bothered with maintanance / repairs. Buy silver with what you save.

Cruel Aid's picture

You lose homeowner rights though.

As in, Someone else has a key and the right to enter.

TheSilverJournal's picture

Absolutely. And you also can't paint whatever color you want. If you have the luxury to spend the money on those things, then by all means, spend on. But don't confuse real estate as an's not. Real estate is consumption. It's like owning a boat, but worse, because a house is immobile.

GeezerGeek's picture

I took a bite of my son's iPhone and broke my dentures. You can bury you silver in my back yard, next to mine. For a small monthly fee, of course.

BigJim's picture

I took a bite of some FRNs and caught halitosis.

StychoKiller's picture

Given the amount of miniature livestock on an FRN, consider yourself lucky! :>D

BigJim's picture

I took some anti-FRNs (silver in colloidal form) and it went away :-)

Mercury's picture

Of course, austerity always seems to be heavily weighted toward the private and not the public sector.  When push comes to shove it's always the firemen and the teachers that are hanging by a thread because *trust us* all other possible fat has already been cut from the public fisc.

Deflation doesn't have to be all that bad for average individuals.  Certainly not as bad as we're constantly told it is.  It's not so hot if you're in the government growing business though.


Pants McPants's picture

That's exactly right.  Police, teachers, and fireman are ALWAYS dangled in front of the sheep to justify more spending.  The fat cat administrators behind the scenes, though?  They're the made men and women who get to sleep in the beds......with sheets.


Cpl Hicks's picture

Sleeping in bed with sheets!

Now you're just mocking all of those brave OWSers out there in their sleeping bags!

That's just plain mean and insensitive, as Barry O would say.

BigJim's picture

It's MISTER Barry O, to you, boy.

redpill's picture

Deflation is great for savers.

Dr. Acula's picture

>Deflation doesn't have to be all that bad for average individuals.

Why are you assuming that austerity causes deflation?

i.e. why do you think reduced government spending would cause the money supply to shrink?


Mercury's picture

Private sector austerity (individuals spending less money on stuff) certainly won't drive prices up.

Reduced government spending would detract from the velocity of money and greater velocity is inflationary.

SheepDog-One's picture

Go ahead, start cutting the subsidy checks almost 50% of americans survive on. Sure, 'green' markets are pretty....someones going to have to start paying for it though.

Archimedes's picture

There will be no Austerity. Since everyone is quoting Ray I will too. Ray basically said that fractional Reserve banking system only survives when credit expands. Once deflation (Austerity happens) the entire system implodes. He laid it out clear as crystal. This is why the US and Europe will print, kick can or do whatever they can to keep the ponzi going until it totally collapses on itself.

Today, the Ponzi continues....

SheepDog-One's picture

Or maybe you have it all wrong and 'perpetuating the Ponzi' is not the game at all, and instead one day soon we see nukes going off in US cities or something along those lines. No one saw 9-11 coming on 9-10.

Ruffcut's picture

Maybe that is what PPT really stands for. Ponzi Perpetuating Team.

The prop desks are in tandum. The fed said, pump or jump, bitchezzz.

redpill's picture

Not all "austerity" is equal.  Ron Paul's proposal doesn't touch social security, instead it goes after federal departments that are largely useless.  So I would argue with Mr. Martenson that he's painting with too broad of a brush.  Cutting government spending does not necessarily mean austerity in the way that Greek pensioners are being impacted in that country.  

Further, bringing troops home from around the world would actually help domestic demand.

This has happened before, following WW2.  The Keynesians were terrified that with massive cutbacks in government spending that the US economy would crash.  Instead it flourished. 

BigJim's picture

Nukes and their fallout would kill TPTB too.... so I can't see that happening to any extent (at least in the West).