Are governments mad with ‘stimulating?’

March 26th, 2009

Share |

In the 1990s, when the Japanese bubble economy burst and fell into debt deflation, its banks were crippled with bad debts. In the ensuing decade, the Japanese government embarked on massive government stimulus programs. Roads to nowhere were built and there were even comments about resorting to military spending (which of course was dismissed later as mere rhetoric because of neighbouring countries’ sensitivities to Japan’s wartime past). When the first stimulus programs proved to have failed in its objective, a second and bigger one was announced. When that failed too, a third and bigger one was announced. Altogether, the Japanese government had embarked on 10 stimulus programs totalling 30 trillion yen. Today, the Japanese government’s debt is greater in size than the entire GDP!

Fast forward to today. The Global Financial Crisis (GFC) had prompted many countries to embark on major stimulus programs. This time round, most of the largest economies are doing the ‘stimulating’- US, UK, Japan (again) and China. The Europeans, on the other hand, are shying away from that. Here, in Australia, our government is also doing the ‘stimulating.’

One of the Einstein’s definition of madness is: continuing to do the same thing, hoping for a different outcome. So, it is pretty clear to us that madness is prevailing.

The root reason why all these stimulation will not work is that we have a structural problem in the global economy. Stimulus spending will not solve the structural problem. As long as the structural problems are not dealt with, the economic slump will not end. As we quoted Wilhelm R?pk’s 1936 economic classic at Overproduction or mis-configuration of production? in January 2008,

It is an indisputable fact that a general slump, which does not permit of the scale of production reached in the boom being maintained, sets in during the crisis, and it is equally indisputable that this general slump is the result of the total demand suddenly falling behind the total supply. But let us make sure what this means and what it does not mean. Under no circumstances can it mean that the cause of the general slump is to be sought in the fact that production has outstripped consumption and that too many of all goods at once are being produced.

Today, governments see the same thing and simplistically believe that aggregate demand is less than aggregate supply. Therefore, the solution, as they understand the crisis to be, is to ‘stimulate’ the economy in order to boost aggregate demand. But as we explained before in Overproduction or mis-configuration of production?, this idea is fallacious.

The whole point of an economic crisis is to correct the structural flaws in the global economy and clean out the wasteful mal-investments. But government bailouts and stimulus are interfering with the correction process. Therefore, this global economic malaise will be prolonged much longer than necessary. If governments go over the top with ‘stimulation’ that don’t work, the outcome will be hyper-inflation (see Supplying never-ending drugs till stagflation).

For our newer readers, we recommend that you read our guide, What causes economic booms and busts?.

Tags: , , , ,

  • It’s a good point that many miss with respect to recessions, it is not as simple as a shortfall in demand but rather a mismatch. Joh Hussman has said this repeatedly over the years:

    Recessions are not caused by a general shortfall in spending, but instead by a mismatch between the mix of goods and services supplied by the economy and the mix of goods and services demanded. Though demand shifts away from some kinds of output that the economy produced in the prior expansion (as we saw with tech and telecom in 2000-2002 and are seeing in housing today), we often see continued demand in other sectors, but the mismatch takes time to correct, and output and employment suffer as a result.

  • It’s a good point that many miss with respect to recessions, it is not as simple as a shortfall in demand but rather a mismatch. Joh Hussman has said this repeatedly over the years:

    Recessions are not caused by a general shortfall in spending, but instead by a mismatch between the mix of goods and services supplied by the economy and the mix of goods and services demanded. Though demand shifts away from some kinds of output that the economy produced in the prior expansion (as we saw with tech and telecom in 2000-2002 and are seeing in housing today), we often see continued demand in other sectors, but the mismatch takes time to correct, and output and employment suffer as a result.

  • Pete

    Great article. I liked the Einstein bit, so true.

    This is the exact reason I think China’s demand cannot just grow from nothing and pull Australia out of a depression. The economic restructuring they would have to go through to change from an exporter to an insular internal demand model is enormous. People who think that this could happen within a year or two have kangaroos loose in their top paddock.

    However…if China goes a bit nuts and decides to spend like Paris Hilton in store that sells dignity, it occurs to me that we China has the potential to start a (destructive) mini-boom, driven by their own cash surpluses buying Australian resources.
    Obviously we won’t know if this will happen until it does (Gov’s being somewhat unpredictable sometimes), but that is the final thing that leaves a question-mark over China for me.

    I think there is a lot of confusion in politics and the media over this exact topic Ed. And I honestly think that they cannot understand why this is a structural problem. That is really quite a worry. I don’t think it is a case of denial…more just a case of narrow scope.

  • Pete

    Great article. I liked the Einstein bit, so true.

    This is the exact reason I think China’s demand cannot just grow from nothing and pull Australia out of a depression. The economic restructuring they would have to go through to change from an exporter to an insular internal demand model is enormous. People who think that this could happen within a year or two have kangaroos loose in their top paddock.

    However…if China goes a bit nuts and decides to spend like Paris Hilton in store that sells dignity, it occurs to me that we China has the potential to start a (destructive) mini-boom, driven by their own cash surpluses buying Australian resources.
    Obviously we won’t know if this will happen until it does (Gov’s being somewhat unpredictable sometimes), but that is the final thing that leaves a question-mark over China for me.

    I think there is a lot of confusion in politics and the media over this exact topic Ed. And I honestly think that they cannot understand why this is a structural problem. That is really quite a worry. I don’t think it is a case of denial…more just a case of narrow scope.