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Tuesday, October 26, 2010

Transcript: 409 Shrinking our way to growth

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Shrinking our Way to Growth -- the Austerity Prescription

The Austerity camp has taken control of the public agenda. Today we have Paul Krugman and Martin Wolf to help us push back. Next time, we'll give you some Robert Pollin. Also today some observations from Rick Davis on the psychology of the household -- the FUD index -- Fear, uncertainty and doubt.

First we have a market minute. Demand Side is no expert in how to make money in financial markets. Our advice for the past decade has been to sell, sell, sell. We have not yet mastered the details of how economic weakness translates into financial asset strength. But here is Mike Larson, an analyst for Weiss Research and editor of the Safe Money Report, courtesy of Marketwatch.


Indeed, someday the casino economy will drain away all possibilities for the real economy, but if there is money to be made ....


In this election season political strategy has trumped public service. It is an open question whether the winner of the election will find his prize worth winning, since it has crystallized or calcified policy around austerity, which can only lead to further decline. As we've said before, we're still in 1930. But we'll get to that in a moment. Here, quoting from Rick Davis at Consumer Metrics Insitute via Global Economic Intersection, we have some salient observations on the economic effect of the elections. Davis maintains the FUD -- frustration, uncertainty and doubt -- index. From his latest post:
... the incessant and mutual mud-slinging (however merited) is actually designed to cast doubt in the minds of consumers about the competence of their current/potential leaders and the long term prospects for the economy under their current/potential leadership.


Unfortunately (and unlike earlier elections in less economically stressful times), until unemployment moderates significantly and household wealth and income start to grow, much of the mud-slinging will ring true. It’s much harder to dismiss the accusations this time around as normal political hyperbole. Visions of a debt-driven economic dystopia, once unleashed via well-funded campaign ads, could to some extent be self fulfilling.

The conventional wisdom about this particular electoral cycle is that the fear factor is coming from uncertainty about 2011 tax rates, given both the expiring tax cuts and the need to address deficits. If taxes are about to go up, rational consumers should be expected to increase personal savings in anticipation of looming tighter budgets. However, the dramatic short term effects that we monitored in 2008 — and are seeing again this year — suggest that something less rational and more emotional is at the root of these changes in consumer behavior. People act on gut reactions, even if it is sometimes subconscious.

If consumers feel powerless in the face of a “Wall Street and Beltway” oligarchy, they may take cheer from having their collective say on November 2. Such cheer was palpable in 2008, when the incoming administration was given a clear mandate (and the legislative wherewithal) for change. This time around, however, the cheer could be muted by the realization that gridlock merely locks in the status quo.

In 2008 we saw a rapid improvement in consumer demand after the electoral smoke cleared. In fact, we saw demand for durable goods (as reflected in our Weighted Composite Index) return to net year-over-year growth by November 30, and our trailing ‘quarter’ Daily Growth Index return to net growth by January 3. This growth was led by a strong housing sector, which by the end of the year was growing at a 50% year-over-year clip. Considering the backdrop for that sector heading into this electoral cycle, this time the lead will need to come from somewhere else.

Rick Davis at Econ Intersect. We put up the entire post on Saturday.
Now How does shrinking your economy lead to growth?

The election season claim that business creates jobs is not correct. If business created jobs in the absence of government regulation and health care legislation, then the eight years of the Bush administration would have seen robust hiring. Instead employment as a proportion of the employable population peaked in 2000, and it has been downhill since. The Bush II presidency saw the lowest production of jobs in any presidency in the post-war era. In spite of the radical reduction of taxes and regulation, business investment was tepid. Virtually all investment came from residential real estate and ancillary industries. All financed by an explosion of household borrowing.

Businesses and their CEO's who now trumpet their ability to create jobs have been in the business of destroying jobs over the past three years, to protect their bottom lines. Thus, it is not government, whose deficit supports whatever stability there is, but the mountains of cash on the sidelines, on banks and corporate balance sheets, that is the placeholder for employment. Uncertainty about regulation and health care is an excuse, a substitute for an explanation.

Before we continue, we should ask who the most prominent proponents of the austerity prescription are? It turns out, particularly in the case of the IMF, they are the same voices who have been guilty of economic malpractice for decades. They are the supporters of securitization, rational expectations, market efficiency and the mathematics-based risk models that failed so spectacularly over the past three years. Absent from this group are any of those who correctly predicted the disaster.

Here is Paul Krugman speaking with George Stephanopolous


Here and we'll have audio from him next time -- we have Robert Pollin. Pollin is co-director of the Political Economy Research Institute at UMass Amherst. Quoting from the abstract of his recent paper entitled, "Austerity is Not a Solution: Why the Deficit Hawks are Wrong:
"Wall Street hyper-speculation brought the global economy to its knees in 2008-09. To prevent a 1930s-level Depression at that time, economic policymakers throughout the world enacted extraordinary measures. These included large-scale fiscal stimulus programs, financed by major expansions in central government fiscal deficits. In the U.S., the fiscal deficit reached 9.9 percent of GDP in 2009, and is projected at 10.3 percent of GDP in 2010. But roughly 18 months after these measures were introduced, a new wave of opposition to large-scale fiscal deficits has emerged.

The arguments developed by various leading deficit hawks are not advancing one main argument or even a unified set of positions, but rather four distinct claims: 1) Large fiscal deficits will cause high interest rates, large government debts, and inflation; 2) Even if the current deficits have not caused high interest rates and inflation, they are eroding business confidence; 3) The multiplier for fiscal stimulus policies is always close to zero and has been so with the current measures; and 4) Regardless of short-term considerations, we are courting disaster in the long run with structural deficits that the recession only worsened.

None of these deficit hawk positions stand up to scrutiny. Pollin argues that by critiquing the four deficit-hawk positions, we can also bring greater clarity toward developing a workable recovery program. This will include fiscal deficits that can stabilize state and local government budgets; maintain sufficient funds for unemployment insurance; and continue support for long-term investments in traditional infrastructure and clean energy. But such fiscal policies also need to combine with credit-market measures that are capable of ‘pulling on a string’—i.e. creating strong enough incentives for both lenders and borrowers to unlock credit markets.
In Europe Austerity has been championed by the new British prime minister, David Cameron. As leader of the Conservative Party, Cameron is a prime illustration of why conservative is a very poor synonym for prudent. The austerity package presented by Cameron was lauded by the IMF, an organization notorious for poor economic judgement, yet still at the heart of official policy making. Here is an edited version of Martin Wolf's comments.


Martin Wolf

Both Wolf and Krugman are counting on consumer demand to return by way of tax cuts, to overstate their positions. It is Demand Side's point of view that reconstruction of aggregate demand must be experienced in the household sector in the form of jobs. Tax cuts will be saved or directed to debt payments. This will have a very low multiplier. Jobs create demand for the entire spectrum of consumer purchases. And to expect industries devoted to consumer production to invest is expecting investment in China to stimulate the U.S. or Europe.

Demand Side requests immediate and large-scale public investment in education, infrastructure, energy and climate change related projects. Direct investment -- perhaps financed off budget by dedicated bonds -- but nevertheless direct employment of people. It is this single-minded resussitation of aggregate demand through public goods that will return us to economic health. If in the course of creating that demand we preserve the planet for human civilization and prepare for the prosperity, so much the better. To rely on the consumer economy's return is to rely on the dynamics that wrecked the economy, including debt, to return as its salvation.

1 comment:

  1. The problem is that many countries need to modify the old model. Consumer driven economies have weaknesses. They need to rebalance their economies.

    The reliance on asset bubbles is moronic. An increase in capital gains taxes would make long term investment in stocks much more sensible. The UK and US need to reduce their trade deficits. They also need to return to a manufacturing economy even if it is simply for the domestic market. Consumers need to cut their personal debts, and that will take time.

    In the short term a labour intensive public works program could be very beneficial. It would enable those involved to de-lever at their own pace and keep the economy going. Up till now all stimulus programs have been inefficient, particularly the Bush tax rebate. Using people to insulate peoples homes could create many labour intensive jobs installing the insulation, and also reduce the nations long term energy needs and dependancy. By opting for labour intensive programs they can minimise leakage of initial stimulus without breaking trade agreements.

    Also longer term the economy needs to switch to a higher level of efficiency. The world cannot sustain the extraction rate of resources at its current rate. This could mean more services and recycling to maintain employment and standard of living.