The Stimulants and the Austerians and the War on Double Dips
This week I have decided to do the weekly review both as a links post and in narrative form. I have already posted the links of the most-read articles (see them here). In this weekly review narrative, I want to discuss the never-ending double dip narrative in the US from a different angle than last week.
I will review how the politics of how we got here and why, despite a strong Austrian bias I have been framing the double-dip issue from a pro-stimulus perspective. As usual, the links embedded will be from last week’s articles with a heavy representation of related earlier posts.
How this double-dip chatter began
Ever since the ECRI data started rolling over in April, an increasing number of economic pundits have become alarmed. The double-dip talk really started in April after Albert Edwards noticed the steep drop off in the ECRI weekly leading index second derivatives along with some other data of a similar nature. At the time, I highlighted his analysis in Albert Edwards: Global economy to roll over in six to nine months’ time; bearish for shares.
As with this piece and subsequent ones on the double-dip subject, I have pointed out that none of these commentators see double dip as imminent. Even David Rosenberg doesn’t see a double dip as a lock. At this stage, we are talking about an anticipated slowdown in growth. In that vein, Edwards labelled the original April piece "Downturn in key lead indicator suggests recovery set to lose momentum." But now, an increasing number of analysts are troubled by the data. Witness the ECRI’s own Lakshman Achuthan finally mirroring my April words "roll over" in this Tech Ticker interview below as the data fall further into negative territory.
I have long said I give a double dip even odds (I officially moved into the double dip camp with this post from in November 2009). But, even odds are not 100% odds. And in any event, these things don’t happen overnight. They are the result of a confluence of economic and political factors; economic policy plays a large factor – which is why everyone is talking about stimulus, austerity and deficits. To understand where we are headed we need to know how we got here – not just economically, but politically as well. That will inform our understanding of likely economic policy
Why Obama is doing an about-face
Let’s go back to when I believe the economy was first emerging from recession. In mid-2009, despite calls from Stimulants like Laura Tyson, the Obama Administration decided to take the middle road on stimulus. Having already passed a $787 billion stimulus package and bailed out the banking and auto sectors, they wanted to concentrate on healthcare. So, for those looking for more stimulus, the answer was no. The thinking was the first Obama stimulus package was going to be enough to jump-start the economy. So the Administration felt it should turn to its social agenda, forget about jobs and let the economy work its magic.
Under pressure from the Austerians, President Obama moved to embrace the rhetoric of ‘fiscal responsibility’ in November, saying:
I think it is important though to recognize that. If we keep on adding to the — Even in the midst of this recovery that at some point. People could lose confidence in the US economy in a way that could actually lead to a double dip recession.
This is a fairy tale. The fact is, regardless of whether one thinks stimulus is effective in the long-run, in the short-run it does prevent recession. So, deficit reduction equals lower GDP growth and lower employment in the medium-term.
Moreover, anyone who actually ran the numbers soon realized that even in the absence of austerity, GDP growth was going to decline in 2010. Paul Krugman predicted almost six months ago (see here) that stimulus would begin to detract from GDP growth by Q3 2010.
At some point between November, when Mr. Obama first began calling for austerity, and today, Mr. Obama’s economic team realized that they had been overly optimistic about the economy yet again. What to do? I’ll get into the long-run issue shortly. Suffice it to say, politicians are most interested in the medium-term because they need to get re-elected. Slowing growth or recession doesn’t get one re-elected. And if Mr. Obama doesn’t help get Democrats re-elected in 2010, the last two years of his Presidency will be very ugly, Hoover-esque even. That’s why you now see Mr. Obama siding with the Stimulants again.
Does stimulus work?
Of course stimulus works. That’s why GDP growth was over 5% in Q4 and over 3% in Q1. Over the short-to-medium term stimulus in the form of tax cuts or government spending is very effective in increasing consumption. Nearly everyone agrees with this statement.
The question is regarding what the goal of economic policy should be over the long-term – and that’s where the issue because more political.
The Stimulants will tell you that when we reach the zero bound, monetary policy looses its effectiveness. Either the government must use fiscal policy to stimulate aggregate demand or the economy will fall into a liquidity trap. A key assumption the stimulants implicitly make with this assertion is that the economy is not self-equilibrating. Essentially, the psychology of falling prices, liquidity constraints, hoarding and depression takes over and a debt deflationary cycle ensues in which there is enormous dead weight economic loss from unwanted and unnecessary bankruptcy and unemployment. I believe this is an accurate depiction of what occurred in the Great Depression (or after the Panic of 1873 for that matter). Moreover, depression, centralization of power, and military confrontation go hand in hand.
The point is that sitting on your hands and doing nothing leads to worst case economic, political, and military scenarios. Sure, austerity might work when one country undertakes it in isolation. But during a synchronized economic slowdown, it does not.
The role of government
The problem with stimulus is politics. I wrote about this in November.
[D]isenchantment with the economic direction has reached a fever pitch and put the Obama Administration on its back foot.
In my view, this is not just because the economy remains weak. Americans are angry because the economic policies used to try to fix our predicament have been both unfair and opaque. They have favored special interests like big banks and much of the maneuvering has been done in secret. All of this has increased distrust of government and weakened the Obama Administration.
The result of the increasing distrust of government has been a renewed questioning of the role and limitation of government in the American economy.
When thinking about government and its role and size, there are three camps of thought.
- Big Government. Supporters of big government believe that government can do good. In this view, an increase in the size of government is not just warranted but necessary in a severe economic downturn in order to fill the void left by the private sector’s fragility. The large scale fiscal stimulus enacted in 2001 at the beginning of President Bush’s first term, in 2008 at the tail end of the Bush Administration, and in 2009 during the Obama Administration are examples of Big Government in action.
- Limited Government. People in this camp believe that government must always be held in check – even in times of economic distress. If not, a self-perpetuating bureaucracy develops, with a cadre of individuals dependent on government and wedded to institutions or programs which no longer have great value. In this view, expanding government is like moving to into bigger house; the new space must be filled with stuff, with size justifying the need for possessions rather than the need for space justifying the size.
- Small Government. Individuals in this camp see government as a parasite which, while necessary in small measure, always and everywhere raises the specter of despotism and cronyism. In this view, government must be kept as small (and as local) as possible because it feeds on society and on power to usurp property and wealth for its own use and that of its cronies.
Now, obviously, the true issue is more the effectiveness of government rather than size. Nevertheless, this fact gets lost as people pick sides more on the size of government.
Austerians distrust government
Here’s what I wrote in December about the arguments used by Austerians:
Politicians will always use public money in part for their own devices… I wrote a post detailing what economist Ludwig von Mises said about stimulus years ago. Here is what he said about the actual efficacy of stimulus as opposed to its theoretical application.
It has often been suggested to “stimulate”economic activity and to “prime the pump” by recourse to a new extension of credit which would allow the depression to be ended and bring about a recovery or at least a return to normal conditions; the advocates of this method forget, however, that even though it might overcome the difficulties of the moment, it will certainly produce a worse situation in a not too distant future.
What you should take away from this quote is…:Rather than use the period of fiscal stimulus to promote private-sector deleveraging and saving and to purge malinvestment, politicians will simply use this period as a way to continue business as usual, making the problem even bigger down the line.
Is this not what we have just seen with the too-big-to-fail bank bailouts? Is this not what we witnessed with the Chrysler and GM bailouts? Has my advocacy of fiscal stimulus not been proved wrong? It seems that Mises’ estimation of the likely consequences of stimulus are spot on.
Six month’s later. This reasoning is still fairly solid. What isn’t solid is the reasoning used by those who question America’s solvency. The legitimate fears behind deficit reduction are inflation and currency depreciation, not solvency. But, the spectacle of bailouts, record profits and large bonuses in the financial sector juxtaposed to 10% unemployment nationally, depression in some cases locally, and record foreclosures means a lot of people are done with the Stimulants. Distrust of government is back to record levels. It doesn’t help that Obama has broken many promises on civil liberties.
As I said yesterday, Obama had one shot to fix the problem and that’s it.
What to expect going forward
I’m done with the politics of this issue. I will say this though. Yes, stimulus can be effective and I would favour a locally administered jobs program to fund productive employment in depressionary geographies and an across-the-board temporary payroll tax cut. If Mr. Obama does allow the Bush tax cuts to lapse, he could always renew them as a temporary but middle class tax cut. But, the point of stimulus is not to resume over-consumption, reward special interest groups or maintain the present allocation of scarce resources. Rather, we should be looking for the money to be saved as households repair their balance sheets and people exit the financial and real-estate sectors. Otherwise you are kicking the can down the road.
What I would like to focus on here and going forward is what is likely to happen politically and economically. Politically-speaking, from here, the Stimulants are busted. The Austerians are going to take control – both in the US and elsewhere. I have been predicting this since October when I wrote:
Deficit spending on this scale is politically unacceptable and will come to an end as soon as the economy shows any signs of life (say 2 to 3% growth for one year). Therefore, at the first sign of economic strength, the Federal Government will raise taxes and/or cut spending. The result will be a deep recession with higher unemployment and lower stock prices.
Nothing has changed to make me feel any differently. Moreover, the mid-term elections will better the Austerians hand against the Stimulants.
Economically-speaking, Charlie Minter and the guys at Comstock Partners gave us ten good reasons why we should see this as an especially weak recovery. Going forward, there are a number of good data points to focus on. John Hussman gave us a few of the best this past week. I will definitely, definitely also look to the ECRI Weekly Leading Index. David Rosenberg gave a –10 bogey as the number to watch. If it hits –10 and stays there for a few weeks, it’s probably game over. Moreover, I agree with Taleb that the debt situation is worse now than in 2008. So, a double-dip would trigger a very bad outcome.
I don’t have a good read on what the BP situation is going to do to the US economy. But the Matt Simmons suggestions about using nuclear weapons to plug the hole seem pretty crazy. Let’s hope he’s the loon his former firm thinks he is on this issue. My sense is the BP situation isn’t crimping growth; it is just redistributing income away from the Gulf.
Next week I may talk a bit more about the European situation. This makes sense as the banking system there is about to undergo some stress tests and I have already outlined which players are important in European finance. The European situation seems to be the one to watch right now since that is where the most financial stress has been these last months.
I look forward to your comments.
*Note: Rob Parenteau invented the term Austerians (a play on ‘Austrians’). I have concocted the term Stimulants as its analogue. No ill-will is meant either way on my part .