Regular readers of this space will recognize this as the third in a series. Irregular readers will not recognize it at all. They will look at us as though we had come from Mars. Earthlings are all convinced that a financial crisis of cosmic proportions befell the planet last fall. Had the authorities failed to act with determination and speed, it would have been the end of the world. In the popular mind the politicians have saved capitalism from its own excesses.
Our views are different, but not extra-terrestrial. Once upon a time, not so long ago, they were even respectable. The gist of our message two weeks ago was that debt is dangerous. It feels good at first. But give a society too much debt – either in its private sector or the public sphere – and someone’s going to get killed. That’s why the present situation is such a delight to serious economists; it offers more data points. We get to see how much straw the feds can add before the poor camel’s back breaks.
What’s the best way to get through a debt crisis? Straight through was our advice last week. For at least a thousand years, the business cycle went round and round without help from central bankers or economists. It is only since these geniuses have been on the case that really serious problems have arisen. The Panic of 1920 – in which the US government did nothing but cut taxes and spending – was quickly forgotten. The Panic of 1929, on the other hand, was followed by massive rigging and jiving by the authorities. It took 20 years and a world war to overcome; today it is still remembered today as the Great Depression.
Martin Wolf, speaking, gravely, for the world’s intelligentsia in The Financial Times last week, proclaimed that: “the only thing worse than rescuing the system would have been not rescuing it.” But he is wrong; of all the many blessings economists may bestow upon a grateful people, improving the economy is not one of them. An economy is a natural thing. It can be improved by the striving of entrepreneurs, the prudence of bankers, and the sweating of field hands. But when it comes to the macro-economic policy, forbearance is the quality that pays. Any initiative on the feds’ part inevitably makes things worse.
The Bubble Era, like the Great Depression, was largely -but not completely – the result of government initiative. Artificially low interest rates – intended to counter the modest downturn of 2001 – sent the wrong message. Consumers – notably those in Britain and America – bought things they couldn’t afford. Producers – notably those in Asia – made things for which there was no real market. Debt piled up. Mountains of it.
As consumers bought more and producers made more the economy grew. But much of the economic “growth” of the 2001-2007 period was fraudulent. It was based on debt spending, not on genuine increases in purchasing power. Debt pretends to be real money. It looks like the real thing, but it is not. It stimulates the economy like counterfeit money. It causes production and consumption, but of the wrong sort. Former Reagan era Office of Management and Budget director David Stockman estimates the level of “counterfeit GDP” at $4 trillion in the US alone.
The fraud was discovered, though misunderstood, when sub-prime debt began to implode. The economy had been kissed hard; millions of houses had been built, bought and sold. Now, owners couldn’t pay for them. All of sudden, the counterfeit money began to shrivel up. Lenders, investors, and householders all began to de-leverage; paying down the debts as fast as they could, defaulting on those they couldn’t.
Rather than come to the obvious conclusion, that they should never have meddled with the economy in the first place, the feds began rescue operations on a breathtaking scale. The British government increased spending to 140% of revenues. America now runs a stimulus program nearly equivalent, in economic impact, to WWII. Not since 1945 have the two pages of its ledgers – debits and credits – told such different stories, with almost $2 of spending for ever $1 in tax receipts. Britain will add almost 50% to its government debt in the next three years. David Stockman expects the publicly held US national debt to almost double in the next five years.
Even at those levels, many economists think the government should do more. Nobel Prize winner, Paul Krugman is one. Richard Koo is another. They’ve warned that the US (and by extension much of the rest of the world) could suffer a Lost Decade, like Japan, if the government slacks off before consumers have finished de-leveraging. At least they understand what is going on. Too bad they missed the point of it. The problem is too much debt, not too little spending. Leveraging up the public sector doesn’t help. Even government debts must be paid – if not by the borrower, then by the lender. The feds are smooching more ardently than any debt lover in history; next, we get to see who dies…or at least who defaults.
Until next time,
for Markets and Money