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.

  1. 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.
  2. 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.
  3. 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 .

  1. jimh009 says

    This is a fantastic post…and really sums up my own views perfectly.

    The problem with stimulus spending in reality – versus in theory – is that …

    1) as you mentioned, it tends to go to projects that accomplish little and those with political connections, and
    2) most people see little if any benefit from stimulus spending as it gets targeted to particular groups, and…
    3) the stimulus spending simply “never ends.”

    In theory, having the government spend during bad times -even if it means borrowing – makes perfect sense. Most people don’t have a problem with unemployment insurance, food stamps, job retraining programs, repairing roads and bridges, etc…

    The problem is that when “good times” return, the spending – and resulting deficits and economic distortions – remain. Worse, much of the deficit spending becomes “built-in” – leading to yet higher structural deficits in the future.

    In my opinion, this type of structure where the government borrows ever more money during both good times and bad is unsustainable – especially when the citizens incomes are flat or declining as has been the case for most Americans the past thirty years. And a unsustainable trend always ends. Due to the large size of the US economy, and because it prints it’s own currency, the USA can probably get away with doing what’s it’s doing for quite some time. Yet, it inevitably will end. There is simply too much debt and distortions in the system right now. The tax dollars to support the spending is no longer there. What you are seeing play out with the various States will, sooner or later, wash ashore in Washington DC too.

    Another problem I have with Keynesian economics as practiced in reality (versus in theory) is that it leads to structural imbalances and ever-increasing debt in the economy – pretty much guaranteeing that when it all ends the end will be a depressionary collapse.

    And I guess that is one of the big problems I have with Keynesian economics – using it frequently prevents the distortions and inefficiencies in the economy from being worked out during normal business downturns. Instead, Keynesian economics papers over the distortions and inefficiencies with ever-increasing amounts of debt. What I fear now is that the USA has essentially years and years (perhaps decades) of distortions and inefficiencies built into it’s economy right now. Working them out will be a long and painful process, leading to flat to declining incomes, strident and ever-harsher politicization and wild and ever-changing swings in what and how the government operates.

    When will it all end, I think, is the question. Like I tell my Mother – who is worried about her pension and social security in the years ahead – it will end when the money is no longer there. Change won’t happen unless it is truly forced for all the reasons you mention in this post. And in my opinion, forced change can only happen when everybody wakes up to the fact that the money to pay for everything is no longer there. Once the “checks bounce” (or to put it another way, the bond buyers stop buying US debt), change will finally happen.

    Finally, and perhaps this is where I disagree with you, I think this is inevitable. Even if Obama and all the other governments of the world had done the “right thing” and had “perfect stimuluses” and no bailouts and everybody loves and trusted their governments, I still think that a deep economic contraction was inevitable. The only time in history that the USA had debt levels (combined personal, corporate and governmental) as high as it had in 2008 was in 1929. No other period in US history even comes close. The result of too much debt is ultimately debt deflation as the debt gets worked out, paid off or defaulted on. In 2008 I don’t think that there was anything the US could do to avoid this fate, nor is there anything the US can do now. The only thing the US could have done differently was to put in place policies to cushion the fall. But, as you mentioned, even those cushions are likely to be curtailed or removed altogether due to misguided governmental spending priorities.

    1. Edward Harrison says

      jim, I actually agree with you that a deep downturn and soft depression was always inevitable with the levels of debt we now have in the household sector – even with a perfect stimulus program. There’s no way around that – and to the degree people are looking to avoid a downturn, you know that the problem will end up being worse down the line.

      1. Anthony says

        “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.”

        Right on Edward!! Effectiveness!!!

        Keynes theory has two parts to it:
        1) Budget deficit and increased debt during recession is better than another Hitler taking power (anyone disagrees?)
        Now, this is the part that government loves, no problems spending money.
        2) Once economy improves the debt must be repaid down to prerecession level.
        That is the part our “effective” governments forget. So let’s stop kicking Keynes!! He has nothing to do with our debt problems.

  2. J. Powers says

    Perhaps you’ve answered this in another post, Edward, but what would things look like if the double dip is avoided? I mean, where are the jobs going to come from?

    1. Edward Harrison says

      Most of the things that could be done have a political element to them that makes it nearly impossible for anything to get done. I have decided to stop making arguments one way or the other and focus instead on what is likely to happen.

      The only thing I see passing Congress is a tax cut – I mentioned a payroll tax cut in the post. But, remember even this will probably be rejected as budget-busting in this environment in which deficits are the main political enemy. So I don’t see it happening.

      Perhaps Obama will try re-instate the Bush tax cuts since this was a Republican proposal but the Democratic base would cry murder since those cuts are skewed toward the wealthy.

      What is likely is that we will see no stimulus or tax cuts and that deficit hawks and Republicans pick up seats in both houses, ending all pro-stimulus rhetoric.

  3. stu says

    Good post. One question though: How does the fact that federal largesse will be offset by state and local cutbacks translate into Obama breaking promises on civil liberties?

    1. Edward Harrison says

      The civil liberties are more about trust of government. If you follow Glenn Greenwald, the civil libertarian blogger, he is well-quoted by libertarians and liberals alike. Even Pat Buchanan quotes him. Greenwald’s pieces on civil liberties go to the heart of the change you can believe in ethos that Mr. Obama was trying to bring to the White House. If he cannot show serious change on the issues on which he won electoral converts (The War in Iraq), all of the other government actions come under suspicion. I think this has been extremely damaging in terms of building credibility on other policies (banks, healthcare).

      1. stu says

        I think I agree with everything you say, but that still doesn’t translate into civil liberties. I think it’s at best misleading (at least in the current atmosphere of gov’t distrust) to imply that falling short of campaign rhetoric equates to some threat to civil liberties.

        Anyway, good night and keep up the good work.

        1. Edward Harrison says

          Stu, take a look at the link I provided connected to that point. All of the issues that Jon Stewart pokes fun at are on civil liberties. That may help explain better what I mean.

          Here’s the link:

          Good night as well.

Comments are closed.

This website uses cookies to improve your experience. We'll assume you're ok with this, but you can opt-out if you wish. Accept Read More