Posts Tagged ‘Keynesian’

Keep up spending- Who?s right? Europe or America?

Thursday, July 1st, 2010

Sometime last year, we were discussing with someone in the finance ?industry? about the possibility of a double-dip recession. Back then, the mainstream assumption was that government spending will somehow ?stimulate? the private-sector of the economy. But we argued that this assumption was simply incorrect. As we wrote in August 2009 at Will governments be forced to exit from ?stimulus??,

In fact, the word ?stimulus? is the most misleading word in economics lexicon because it conveys the idea of a surgeon ?stimulating? a heart into self-sustained beating. In reality, what government interventions did was to put the economy on a crutch.

Based on this faulty assumption, the financial market?s expectation is that the worst of the GFC is well and truly over and that the global economy will return to ?trend growth.? But as we wrote in January 2009 at Soft landing hope built on faulty framework assumptions,

Built into the blinkers of the mainstream neo-classical economic framework, the assumption is that the economy is like an elastic band that will spring back to its previous un-stretched state of ?equilibrium? after being stretched by external ?shocks? (e.g. global financial crisis). For those who studied economics at university, you will realise that the phrase ?external shock? is often used in the text-books to describe phenomena that are beyond the scope of economic model. Furthermore, you will find that your text-book are full of simultaneous equations, which implies some sort of ?equilibrium? has to unquestionably happen.

Today, there is a lot of talk in the financial markets about the threat of a double-dip recession. The expected (assumed is the more accurate word) recovery in the United States seems to be stalling. China is enacting policies to slow growth. Europe is mired in sovereign debt problems.

But for you, our dear readers, all these should not come as a surprise. As we already wrote in March this year at Black Swans lurking because Uncle Sam has less margin for error,

If the right word is used (e.g. ‘crutch,’ ‘prop up’) to describe the counter-productive government policies of spend, spend and spend, then it will do wonders to increase the economic IQ of the masses (see Are governments mad with ?stimulating??). Consider this very simple chain a logic:

  1. Someone is falling.
  2. You place a crutch to prevent him from falling.

Isn’t it plain common sense to see that once you remove the crutch, that person will crumble? From this, it follows that government crutch (‘stimulus’) lifts government expenditure to a higher plateau. Once we have bigger government, it is very difficult to shrink it as the difficulty currently faced by Greek government shows.

This is the issue that the Europeans are facing right now. If governments attempt to ‘stimulate’ their stagnant economies by spending big, their fiscal deficits will continue to grow, even to the point of no return. Consequently, the financial markets will lose faith in the governments’ debt because it will mean either (1) raising taxes, (2) default, (3) printing money, or (4) some combinations of the three. That’s their motivation for pledging to cut fiscal deficits in the recent G20 Summit.

But the problem is, if they cut their fiscal deficits (i.e. cut spending), their economies as measured by the GDP will shrink. Not only that, a shrinking economy implies a shrinking tax receipts for the governments, which in turn implies that they will have greater difficulty trying to repay existing debts. When that becomes obvious, you will see the bond and stock market reacting very negatively.

But for the Americans, since their government bonds are not yet under attack (given that among other reasons, the USD is still the world reserve currency), their more immediate problem is domestic growth. In fact, demand for American government bonds increased as a result of the flight to ‘safety.’ Hence, Obama was on record to urge the Europeans not to kill growth by shrinking government spending. But as Niall Ferguson said, at this current trajectory, the US will be like Greece in several years time.

So, who is right? The Americans or the Europeans?

Obama could urge for a policy of continued government spending because time is more on America’s side. The financial wolf packs are currently busy with Europe. So, Obama must be thinking that if America can try another shot at ‘stimulating’ their economy, maybe in due time, the government can then let the private sector take over. That will be the time to reduce the US government’s fiscal deficits. Hopefully, that can be done before the financial wolf packs set their sights on America.

Using an analogy, the current situation is like Europe being pressured on two fronts simultaneously with no room to move. America, on the other hand, is facing pressure only on one front. Obama’s plan is to send troops to that front, deliver the knock-out blow before sending troops to face off the looming second front. The plan will fail spectacularly if the enemy arrives on the second front before the knock-out blow on the first front can be concluded.

So, place your bet on whether you think America’s plan will succeed. If you think they can pull it off (i.e. honour their debts), then buy US Treasuries (American government debt). If not, get physical gold.

How to buy and invest in physical gold and silver bullion

Government’s contradictory messages

Wednesday, October 22nd, 2008

Back in Can China save Australia?, we mentioned about SBS’s Insight program, Greed. As we read the transcript of that program, we cannot help but realise that while the government officials are busy trying to deal with this crisis, they are sending out contradictory messages as a side effect.

For example, take a read at this:

JENNY BROCKIE:  But what sort of possibilities are we talking about here? I mean unemployment going up to 10%, 20% in the event of this taking hold in Australia? What could happen?

LINDSAY TANNER:  Definitely not. None of us can see into the future and the international crisis is obviously so unprecedented that it’s very hard to make predictions, but the fundamentals in Australia are very strong. We’re better off than virtually anybody else in the world to deal with these problems and we remain optimistic that we will be able to ride through this buffeting in reasonable shape.

On one hand, Lindsay Tanner ruled out the possibility of Australia’s unemployment going north of 10%. Yet, on the other hand, he said that no one knows the future and make predictions. If you notice, by saying “Definitely not,” he is already making a prediction!

Incidentally, in Jobless rate may double as China slows, JPMorgan Australia’s chief economist Stephen Walters said that

“We now expect the jobless rate to more than double to 9% in late 2010, from the current 4.3%,” Mr Walters said. “Softer growth in one of Australia’s leading export destinations means Australia’s export volumes will be lower, as will be the terms of trade.

“That said, on our forecasts, there will be 1 million unemployed Australians by the second half of 2010.”

The current way of measuring the employment rate includes those who are under-employed (see Nearly 600,000 Australians under-employed). When the economy slows down, it is those kinds of jobs that will be shed first, especially jobs in businesses that depend on discretionary spending (e.g. retailing). Therefore, a figure of 1 million unemployed people is not so unthinkable after all.

The next contradictory message from the government is on spending:

JENNY BROCKIE:   OK, there are quite a few things in what you’ve said that I’d like to pick you up on because we live in very contradictory times at the moment. You’re saying we should be thinking about thrift. You’ve just released a $10.4 billion package and you’re telling people to go out and spend. I mean, should Siobhan keep spending, keep getting into debt? What’s the message the Government is sending at the moment?

We believe that the government’s $10 billion stimulus package is a misguided Keynesian policy that will not solve the problem.

Firstly, as we said before in Will Australia?s own pump-priming work?, it is far too little to combat the deflationary force.

Secondly, even if it is big enough to induce the masses to spend, it is the wrong medicine. If such policies are carried out to the extreme, the outcome will be hyperinflation (see Bernankeism and hyper-inflation). As we explained in Supplying never-ending drugs till stagflation,

Students of the Austrian School of economic thought will understand that indiscriminate ?printing? of money will worsen the plague of mal-investments and structural damage in the economy. Like drugs, the more you ?print? money, the less effective it will be in stimulating economic growth (see What causes economic booms and busts?). Eventually, it will come to a point that the economy will not respond positively anymore no matter how much money is being ?printed.?

Without the liquidation of mal-investments and restoration of the structural imbalances that is brought about by deflation, applying bigger and bigger stimulus packages will only function in similar ways to drugs- more and more for less and less effect. The reason why Keynesian reflationary pump-priming worked during the Great Depression was that it was applied after the cleansing effects of the deflation had done its work. But today, in reaction to the financial crisis, governments all over the world are doing so before the purge of fire. As a result, the much-needed economic correction that the economy had to have will not happen.