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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Mercury's picture

I don't think you need expansion beyond a certain point.  as long as the net interest margin is sufficient (the old 3-6-3 rule) things can hum along quite nicely with credit stasis.

With ZIRP and too much debt overhang however...not so much.

Archimedes's picture

Totally disagree. What do you think The US Government is doing running 1.3 Trillion in deficits? They are taking up the credit slack for the consumers. Have the US stop deficit spending and the economy pancakes! Debt and credit are the same thing. The Government is borrowing from the future. Which is credit.

Mercury's picture

Fractional reserve banking (at the community bank level anyway) and (government) deficit spending are two different things.  We've had the former without the later before.  The government has now painted itself into a corner policy-wise plus they are increasingly in business for themselves at this point anyway.  So, they'll run up huge deficits and worse to keep the leviathan alive.

Archimedes's picture

I have realized that there are lots of Perma Bears and lots of Perma bulls, but very few people who take the market for what it is and trade without either bias.

SheepDog-One's picture

Sounds nice and reasonable after the fact, but 2 days ago even the bulls were saying we're on very thin ice here. So Europe pulls an imaginary rabbit out of the hat, markets marvel at its splendor and rise 4%, and today everyone says 'Well, shoulda been rational traders and went long'. All well and good for rear view 'traders'. So anyway, whats your next week trades look like?

Archimedes's picture

I hear ya Sheep. I could have gone long yesterday just as easily as I coulda went short. So today I am looking at stocks and ETF's up 7, 10 event 15% saying I could been a contender. But I could have just as easily been wrong and down 15%. That is why I am not in the market. Because it is not being driven by funtamentals. It is being driven by government policy.

And I wa not referring to this day in particular. I was refering to Chris and other pundits as a whole. A man who is always a bear. Just like people like Cramer are always a bull.

SheepDog-One's picture

Well at some point here the bears gotta be right in a big way. We just dont know when. 

I dont believe that theyll just keep kicking the can until it blows up in their faces, theyve got to have some other big 'game changer' planned ahead.

Ruffcut's picture

The fact is that crowded bear trades, often get beat up bad. We seen it time and time again. Shorting is like putting a bullseye on your forehead.

You can hedge with call options, etc, but will always be paying for protection where they still collect money from you.

THose woho have cash and bought enuff PM, items of sustainability and a simpler life are the better off.

Trading on most days is like chasing your own tail. that's why alot here are blog addicted. Just bullshitiing and less trading seems less stressful.

The casino, has some debt issues. They are calling all their patrons to the  table.  "let's play a few more hands". Me say, all bets are off telling them go play with themselves, in the corner of the oval office.

topcallingtroll's picture

Hey sheep

I tried to get u into EWZ.

hehe. Ssome of us get a few trades right.

Ya should have shorted silver with me too.

Aahh...the glory days.

JR's picture

As Nathan Marin put it today, the U.S. trumped up QE3 GDP “rose to perfectly meet the 2.5% ‘growth’ expectations. Again, this is a completely bogus measurement with inflation way understated which overstates growth.  Also, they count the creation of debt, including our government’s deficit spending as ‘productivity.’"

Nathan Martin has one of the broadest and most comprehensive understandings of finance and debt in the world today and he’s willing and brave enough to publish it. In today’s political climate, he’s the opposite of the paid economists supporting the Establishment to cover up its corruption and lies regarding the equity markets and, especially, its manipulated government indices – all manipulated by those who manipulate the currency.

Says Nate: “GDP is not a measurement of ‘production,’ it is a measurement of money and moneyness. And the comparisons of debt to GDP are completely fallacious! What matters is not a nation’s debt to the nation’s trumped up ‘productivity,’ what does matter is the nation’s debt compared to the nation’s income.  Comparing the nation’s debt to GDP is like comparing your own debt to your neighbor’s productivity – why do they have to do with anything? Nothing! It’s completely ridiculous. What matters in regards to YOUR debt is YOUR income – period.”

tsx500's picture

right on, i get Nathan's daily email rant, he is a ' don't miss ' .    

Pants McPants's picture

What this "system" needs, and I assume the author means the .gov/banker construct, is collapse.  Fascism, to any degree, is always and everywhere a bad thing.

SheepDog-One's picture

What we need is just 1 adult somewhere in a position of power to throw in the monkey wrench.

GeezerGeek's picture

I volunteer to be dictator just long enough to throw that wrench. There's no one else I would trust to be dictator, and I must be an adult because my package of diapers says they are for adults.

Mediocritas's picture

Sounds like Chris Martenson has discovered Cullen Roche.

Little John's picture

I liked that definition of collapse - “radical simplification”.

Dr. Acula's picture

"emerging problem of resource scarcity"

That's absurd and retarded. Scarcity is eternal and ubiquitous. It's an inescapable fact of the human condition.

"economists typically no longer have a solution for Los Angeles, or for Southern California. Or, for that matter, the United States."

What are you tring to solve exactly???

If you want more problems, economics shows that a central planner engineering a "solution" is a great way to cause them. Here's one example:

"Ludwig von Mises argued in a famous 1920 article "Economic Calculation in the Socialist Commonwealth" that the pricing systems in socialist economies were necessarily deficient because if government owned or controlled the means of production, then no rational prices could be obtained for capital goods as they were merely internal transfers of goods in a socialist system and not "objects of exchange," unlike final goods. Therefore, they were unpriced and hence the system would be necessarily inefficient since the central planners would not know how to allocate the available resources efficiently.[1] This led him to declare "...that rational economic activity is impossible in a socialist commonwealth."[1] " -

Why not try learning some economics before condemning it?


Cugel's picture

Even more remarkable is that the author who has just discovered scarcity considers it more "humane" to drain off further scarce resources keeping wealth-destroying enterprises afloat. 

I think you can add "absurd and retarded" to the list of inescapable facts of the human condition.

PulauHantu29's picture

Come on...recession is over...I heard it on TV today.

Eally Ucked's picture

You don't need any austerity programs, you will get it through your pensions funds. They are down and will never recover, but sheeple won't notice it. Next step will be cuts in all promised and contracted benefits programs. Of course all those "true capitalist" will approve it, who the fuck cares about contracts now a days. You signed the contract 20 or 30 years ago for your skills and work, but it is void now because they spent too much for bonuses and moving your industry to China.

LongSoupLine's picture

blah, blah, blah...more "common sense" words and charts that do NOTHING to ward off the  greedy and power driven elite whom are making all the self-serving decisions that continue to bury the majority.

Do you know how many times I've written my "representatives" with cut-n-paste "facts" from ZH and my own thoughts and ideas?!?!  The best I've gotten in return is a Dear John form letter.

I'm fucking fed-up with it all...we in the trenches ARE ON OUR OWN!

Archimedes's picture

Off topic but: god does DRV look attractive at 8.75! Pull the trigger you pussy!

LookingWithAmazement's picture

The US economy is growing, no recession or collapse. All the doomprophets and their websites can go off the table. Boring world we live in.

LawsofPhysics's picture

Indeed, and since the booming economy is going to need resources to keep booming, I think you know where to put your money.

SheepDog-One's picture

'Economy is growing', no thats fake money printing youre seeing, along with total BS 'GDP' prints.

Dr. Acula's picture

>The US economy is growing, no recession or collapse.

True. Just like nominal wages have grown in the last 40 years.

I can also make my organ grow, if I redefine the "inch" to be a millimeter.


GeezerGeek's picture

The author says "the ability of Developed Economies to coherently allocate resources" is a problem. By coherently does he imply a cluster of policy wonks getting together in a circle to come up with a plan to allocate resources? I prefer the invisible hand in Smith's Wealth of Nations. I don't like some elitist group telling me what kind of targeted transision process we need.

We do need to transition to a constitutionally limited central government. If government shrinks and stops interfering with the natural course of economic events then TBTF entities will indeed go the way of the dinosaur, as they should. If energy is a problem, let's allow the free market to determine if 'drill, baby, drill' will solve the problem, not some anti-growth ecology-minded bureaucrat. Economically speaking, government is a friction-generating element acting as a brake on the economic engine.

Facetiously: the author states that nearly 7% of the U.S. population lives in the five large counties of southern California. Does anyone have any information about the percentage of the Mexican population living there?

JR's picture

Thanks for the question: I’m looking for the answer.  In the meantime:  2010 U.S. Census results show that “the changes in California and San Diego County closely mirrored those of the nation.” Here are random 2010 U.S. Census statements:

San Diego is home to the 10th-largest Hispanic population, among the most populous counties nationwide. It also had the ninth-highest percentage of Hispanics in the country, among the most populous counties.

1st -- California’s ranking in the number of Hispanic residents. It is tied for second among all states in the percentage of Hispanics in the total population.

46.5%  -- The percentage of Hispanics in the United States  is 50.5 million Hispanics; 46.5% of them in 2010 lived in California or Texas. Those two states were home to half of the Hispanic population in 2000.

Diversity across the U.S. is on the rise.

The greatest increase occurred in the Hispanic population, which accounted for more than half of the country’s population growth in the past decade.

More than 9 million Americans checked multiple race categories on their 2010 census form, up 32 percent from 2000.

“This really is a transformational decade for the nation,” said William H. Frey, a demographer at the Brookings Institution in Washington, D.C. “The 2010 census shows vividly how these new minorities are both leading growth in the nation’s most dynamic regions and stemming decline in others.”

Nationally, Hispanics and Asians were the two fastest-growing demographic groups; both populations soared by about 43 percent from 2000. Hispanics accounted for one in six Americans last year; among those under 18, Hispanics were roughly one in four.

Births and domestic migration drove the Hispanic increase, demographers said. 

razorthin's picture

2.5% gdp? 0% chance.  Many suckers taken in today.

csmith's picture

Simplest and most meaningful relationship in the U.S. economy today:

Diesel: $3.99/gallon

CNG (equivalent energy value) $2.39/gallon


Even with ZERO subsidy, the economics are compelling. The payback is less than 15 months for fleet operators of even moderate size. It will happen.






malek's picture

Unfortunately, there are not many CNG models available any more...

El Viejo's picture

"The connection between needs and actual production is badly broken." 

It started in the early 80's. CEOs looked and found a way around regulation and taxation. Reagan supported this effort with the Self Employment tax. Cheap labor was sought and found in China. All to support Wall St. and stockholders. A quick profit. All the while the private sector was forced into debt and boomer-demographic-less-spending all combined to form the perfect storm of: over production, high personal debt just to maintain status quo, high energy costs, governmental high salaries and benefits and reduced boomer spending as they approach retirement. And to whom does the stimulus go? Why the ones who do not need it. And low rates to further entice more into debt. Amazing! Like it or not Obama was right when he said we will all have to contribute. The Feds have frozen federal salaries for three years. But just try and refi your house. Oh no your not taking from our pension pot. And just try and reduce benies to state government leeches. Oh no your not reducing our salaries or benies. And just try and increase taxes for the rich who do not buy that much anyway and instead put unecessary money into the already overstuffed markets.

Bring production and consumption back into balance or prepare for this to be with us all for a long time.

NEOSERF's picture

Lot of big words in here but overall I agree.  The structural misallocation of funds by the government (I say mis even though so much of the daily spend is not voluntary) to entitlement programs, maintentance, wars that have not tangibly raised productivity is probably not fixable at this point.  Too many factions to cut anywhere and try to re-allocate say $200b/yr from Medicare towards energy R&D or college education reform.  At this point an increasing % of taxpayer money will end up going to keep grandma warm or to repave a stretch of I-95 which provides no real increase in value to us as a nation.  Velocity of money is not a subsitute for investment in key growth areas. 

sbenard's picture

Interesting set-up, but this really is just an elaborate sales spiel! Once you click through to Mr. Martenson's website, you must first acquire a "free" username and password to the website. But if you really want the "answers" he proposes, you must PURCHASE a subscription. I don't mind the need to purchase, but it's a bit disingenuous to masquerade a sales letter as an article on ZH, when its nothing but a teaser to buy a product. This isn't an article; it's an ADVERTISEMENT!

daxtonbrown's picture

[What the system needs instead is a more targeted transition process, ]

You wouldn't need a transition process if you let a free market eliminate the weak before they got too big to fail. Now you are just putting band aid on band aid on a gangrenous gaping hole.

Good luck with that.

antonwarnung's picture

The Fed is a complete  joke.  They are so worried about deflation they don't realize they are killing the consumer which will eventually kill whomever is left that they think they are trying to protect.  The reason confidence is down but spending is up is that at some point with the prices of energy we have had and the inflation being shoved down our throats we have to buy things.  Look cars wear out shoes wear out.  The mood is sour and Americans don't feel they have a choice sometimes.  Well they do.  Fix the old car, polish the shoes, boycott all the big corporate stores.  If there is anyone left in your world selling local products buy them.  Give all your old clothes to friends who can use them.  Grow tomatoes in you front yard and give some to your neighbors.  This will be the new reality when this joke a stock market led prosperity evaporates.  It will evaporate because it isn't real.  Make money from it if you can while you can but don't be fooled into thinking it can last and left to holding the bag.  In the mean time take your frustration out by meeting real people and having real experiences.


antonwarnung's picture

well what are you waiting for?

Gamma735's picture

Hell, in Texas, we are drilling more than 5,000 new oil wells in 2011!

antonwarnung's picture

Good we need to be.  This will probably be enough to keep production flat even at these prices far above historical averages.  Peak oil believers will be the first to tell you that the earth will never run out of oil.  Most of the easy and cheap oil is no more though.


malek's picture

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.

The statement is completely useless without a time frame! 

When will oil prices start seriously inhibiting economic growth, within the next 5 years, or a decade or quarter century??
Do you believe such an estimate to be static, i.e. very unlikely to be pushed out by any kind of adaptation?