Saturday, April 26, 2008

Cure, effect, cause

A paper from the Levy Economics Institute is arguing (at least theoretically) for an extra US fiscal stimulus of 4% of GDP. That's $600 billion.

The authors say that the effect would be better if this reflation came in the form of additional direct government spending, though they acknowledge that it still wouldn't immediately halt the economic decline:

It is somewhat discouraging to see that even a relatively large stimulus plan will fail to prevent a substantial loss of output. But over the medium term, as the devaluation of the dollar and reduced spending begin to exert a moderating effect on the current account deficit, foreign trade will boost output and employment, providing the impetus for renewed growth.

Karl Denninger begs to differ (though in his case, he's still talking about transfers of money, rather than direct government expenditure):

But now we have reached the point where we need $5 in debt to create $1 worth of GDP. As debt levels rise this ratio goes parabolic and ultimately becomes impossible to sustain. That we have reached a 5:1 ratio means that the game is basically up, and the rapidly rising rate of defaults across all areas of consumer debt mean that this "engine" to fuel "growth" simply can't find any more fuel, despite the desires of the bankers and merchants to "make it so."

The Levy paper has echoes of FDR's 30s rescue, but Denninger is more concerned to compare the present mortgage bubble with the one that led to the Crash of '29:

...we've done this before... We saw, in fact, nearly the exact same pattern of practice, fraud and theft that were featured in the housing bubble during the years just before The Depression, and those "standards" in fact were a primary causative factor OF The Depression!

So maybe both parties are correct.

It's also possible that the Uk has got it wrong even worse than Uncle Sam. $600 bn is about £300 bn sterling, but adjusted for relative population size that's only equivalent to £60 bn pumped into the UK economy. We're already talking about a possible £100 bn-worth of mortgage garbage being swapped by HMG for government bonds - and our current fussing over Gordon Brown's crumbling reputation suggests that Prudence wouldn't dare try to reflate with even more direct government spending.

Besides, we are starting with a higher debt-to-GDP ratio than the USA, a State that consumes a bigger proportion of the economy, and a populace that suffers a significantly lower level of personal income on a Purchasing Power Parity basis.

Maybe that's why the pound is matching the dollar in its downward trajectory, and may even overtake it.

I've been wondering recently whether the ordinary investor of the future will be more interested to play in the foreign exchange markets, rather than stocks whose value is lied about, manipulated by rumour and sovereign wealth funds, and nibbled half to death by fees, commissions, taxes and inflation.

UPDATE - Karl Denninger is emphatic that it can't work:

Sack, no.

You can't spend $600 billion in deficits without it coming back SOMEWHERE.

Government spending is not a net positive. You can't only get to a net positive via growth in GDP.

Debt-initiated spending only returns $1 for every $5 taken on in debt.


dearieme said...

The point about "echoes of FDR's 30s rescue" is that FDR's "rescue" didn't work. His one big success was that he stopped the bank dominoes going down: a financial success. But his economic policies failed; the Depression went on and on and on.


Wish I had enough economics to answer that - but then again, if economists are experts, why are we where we are now? I understand some say that the Depression was exacerbated by tightening the money supply instead of loosening it a la (au) Galbraith; yet there was a lot of direct government spending, which if the Levy Economics Institute is right, is the same thing, only better. All those construction projects, and American State histories written by otherwise unemployed writers, and so on.

Maybe we need a big failure to recommence the path to success - except the penalty won't be felt equally by all.

Should the welfare system as a whole be subjected to the "moral hazard" argument? Should payment of unemployment benefit be time-limited? Oh, dear.

Oh, now I've got it: Let's become tenured academic economists and argue endlessly in favour of free trade... this will please big business and the foreign powers that they're selling the country to. (Sorry to end a sentence with a proposition.)

Ryan said...

"I understand some say that the Depression was exacerbated by tightening the money supply"

Some say that, but that is like saying Churchill "exacerbated" WWII by putting up a fight!

Fact is that the problems caused by the debt explosion in the 20's were always going to cause a catastrophe. Americans tend to obsess about the tightening of money supply after the crash, but in Germany the hyperinflation approach was just as bad, as it rendered paper money entirely worthless.

Britain didn't fair that badly during the Great Depression. The fact that it had a huge empire to rely on meant it was operating within a closed trading area, relatively self-reliant for raw materials and food, regardless of the external situation. Of course it would be different now, because we are highly reliant on free trade with countries which we don't control. If we want to protect ourselves from such instability in the future we should ensure that we buy enough farmland and other sources of key materials overseas so that we can operate our own closed trade area for vital food and other supplies. Unfortunately we haven't really concerned ourselves with import strategy since the 70s.


Welcome back, Ryan. I entirely agree with you that we should have a national survival strategy. Perhaps it should involve leaving the EU and strengthening our Commonwealth links.

Ryan said...

I would agree with you Sackers. Makes far more sense to have a trading agreement with trading partners we really need and can benefit from, rather than trading agreements with our closest competitors whose only interest is dismantling UK business to prop up their own failing businesses.Why are we subsiding the Irish so that they can take away our businesses and inward investment without even having to fight for it?

CityUnslicker said...

I don't think the comparison with German hyperinflation is fair at all. Germany was a wreck, politically and economically after WW1 and it never recovered due to the burden of reparations to the Allies.

Hyperinflation will not likely be a threat to us, nor deflation as the rising world population and resource scarcity puts paid to that.

No this issue will be stagflation - high inflation and veyr low growth. This will help with the long-term debt, at the cost of current income and jobs.

As ever, the baby boomers like Brown are all fine. Final salary pensions, houses worth a fortune. Their children are going to pay a high price in their lifetimes though - no utopia for us.


CU: thanks for your expert input. But Germany is not the only case of hyperinflation, and they're far from all pre-WWII:

...and Buffett was punting on the Brazilian real recently!