On Britain’s Austerity and Rosenberg’s Depiction of Obama as Herbert Hoover
I have written a post or two offering the opinion that Barack Obama faces an economy more akin to Herbert Hoover’s than Franklin Roosevelt. See "Barack Obama as Herbert Hoover" where posited the following:
My intent here is not to malign Obama, Roosevelt or Hoover or make facile comparison but to identify important differences between the economic situation facing Obama and the one that faced Roosevelt.
In my view, Obama faces a situation more akin to the one Herbert Hoover was forced to deal with because the economy is sill bottoming, unemployment is still rising and consumer spending is still falling. On the other hand, Roosevelt had the advantage of coming into office just as recession ended. This is an important difference in terms of political and economic constraints.
The reality is that this economic downturn and the financial crisis which created it is very large in magnitude and has deep structural roots in a leveraging of the household and financial sectors of the US economy. Moreover, the aftermath is global in scope as the on-going crisis in Europe, ratings downgrade in Japan, riots and government overthrow in Tunisia and civil unrest in Egypt demonstrate. I see these events as all inter-related due to the debt issues, the economic malaise and the economic policies used to counteract it.
The UK and the US are remarkably similar in their heavy dependence on financial services and the housing bubbles which preceded crisis. The similarity is greater when one looks at the initial political response in terms of deficit spending in both countries, double digit percentages of GDP. In the UK the budget deficit was a massive 11.4% of GDP in the last fiscal year. In the U.S., the federal deficit for the fiscal year ended September 2010 was $1.294 trillion or 8.9% of GDP, down from FY 2009’s 10%. Both countries have their own national currencies and central banks that have engaged in quantitative easing to support the economy. And both countries have very low interest rates despite massive deficits, unlike deficit spenders in the Eurozone without national currencies where national solvency is a gripping concern.
In many ways, this budget-busting spending makes sense due to the huge shortfall in private sector demand as the private sector contracted and tens of millions were thrown out of work. If government had countered this contraction in the private sector with one of its own, a Great Depression was sure to come. An appreciation of the financial sector balances makes this clear. That’s what I was talking about in October of 2009 with "Barack Obama: “if we keep on adding to the debt… that could actually lead to a double-dip”. "
But since that time, the US has resisted austerity while the UK has embraced it. In my mind, this is the best real-time economic experiment we can have on what does and doesn’t happen as a result of government spending. Personally, I think the budget deficits in the U.S. are unsustainable and I have written at length as to why. Nevertheless, I recognize that the large majority of the deficit in the U.S. has been driven by an output gap due to massive un- and under-employment.
My criticism of the Obama Administration has more to do with its lack of fight in creating jobs. And to the chagrin of my Keynesian readers, I am not talking about artificial boosts to aggregate demand. I don’t buy into the ‘aggregate demand is the only problem’ propaganda. The U.S. and the UK were on an unsustainable course with the FIRE sector (financial services, insurance, and real estate) sucking up an excessive amount of real resources that did not add to the longer-term capital formation. It certainly made a lot of people rich for a period of time. But for the societies as a whole, this misallocation of capital has been destructive, much more so than the telecom and technology misallocation which preceded the housing bubble.
The aggregate demand (AD) proponents act as if solving the AD problem makes everything ok. Are they saying that we want to return to the days of overinvestment in housing and financial services? Question: if we increased AD enough to close the output gap, would the unemployment rate in the housing sector be above the unemployment rate in other sectors? Question 2: is it not true that the housing and financial sectors saw an enormous fall in unemployment before other sectors, causing a ripple out into the rest of the economy from the largest areas of net addition to GDP as AD fell? Is it not probable that a collapse in the main driver of employment (FIRE sector) would ripple across the entire jobs market and induce a general fall in aggregate demand? Look at my credit crisis timeline and you can see that employment was plummeting in financial services well before the major uptick elsewhere.
Here are the Bloomberg headlines, all before Lehman collapsed, by the way:
- 2008 01 24 Morgan Stanley, Lehman, Credit Suisse Cut 1,640 Jobs
- 2008 02 26 Banks Cut More Than 28,000 Jobs as Subprime Losses Mount: Table
- 2008 03 24 Wall Street Firms Cut 34,000 Jobs, Most Since 2001 Dot-Com Bust
- 2008 04 22 Banks Cut 48,000 Jobs as Subprime Losses Mount: Table
- 2008 05 06 Banks, Brokers Cut 65,000 Jobs as Subprime Losses Mount: Table
- 2008 05 27 Banks, Brokers Cut 83,000 Jobs as Subprime Losses Mount: Table
- 2008 09 26 Banks’ Job Cuts Reach 121,000 as Credit Woes Spread: Table
Not all unemployment will happen at the same time as proponents of the AD story assume. When you have a financial crisis brought on by a misallocation of resources, it will begin with the financial services industry and overbuilt sectors like housing, spread to capital goods sectors like autos, and then spread to other sectors as aggregate demand falls. What I am saying here is that arguments about unemployment that are grounded in aggregate demand and arguments grounded in structural unemployment are not mutually exclusive. Aggregate demand is clearly lower than in 2007 and it has been maintained by government. Once AD has been revived, the structural issues – with many people having made lives around sectors that are in relative decline like housing – will still be operative. It is just like the structural issues that have faced the manufacturing sector. Or the structural issues that faced the oil patch between the mid-1980s and the late 1990s. There is no either or. In fact, when I hear comments that it is all about aggregate demand, it draws a visceral negative and emotional response from me in the opposite direction – this from someone who just argued that stimulus was necessary and who has consistently said the 2009 stimulus package was too small. That should tell you something; these all or nothing arguments are divisive and produce no positive outcome.
See my post Japan: stimulus without reform leads to a policy cul de sac for why I think the structural issues are important. And given Japan’s sovereign debt downgrade, this is something the U.S. and the UK need to understand. One last point here on Japan, when I wrote about this period as a recovery within a depression, I said the following:
- Most countries are in a state of economic weakness. That means consumption demand is constrained globally. There is no chance that the U.S. can export its way out of recession without a collapse in the value of the U.S. dollar. That leaves the government as the sole way to pick up the slack.
- Since state and local governments are constrained by falling tax revenue (see WSJ article) and the inability to print money, only the Federal Government can run large deficits.
- 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.
The point is that it is never going to be politically feasible to run deficits that are double-digit percentages of GDP while printing money to keep the economy afloat and stimulate aggregate demand for long. It wasn’t possible in Japan, which is why they always sought to rein in their deficits, precipitating another recession. It isn’t possible in the UK or the US either. One can make all sorts of intellectual arguments that this is what should be done until we hit full employment, but politically, I don’t see it. That’s why the structural issues have to be dealt with swiftly.
I credit Obama in the US for taking the better path and debit Cameron in Britain for forcing excessive cuts on the UK much too early. And I think the potential double dip in the UK is not about weather; the poor British economy is also about austerity. The different outcome in the US and the similar outcome in Ireland point in this direction.
So, what about the Hoover comparisons for Obama? I still think they are apt – the reason Obama must still resist immediate austerity with the states and municipalities already in a world of hurt (which doesn’t mean I think he needs to subsidize banks, housing or autos, by the way).
So, I think that’s where we are: in the technical recovery phase of a double dip recession that is a once in a generation period of balance sheet repair. If you want to use the Great Depression as a guide, we are closer to 1931 in terms of events and timing (see Thinking about Creditanstalt today). But the policy response has been much more aggressive this time around. Ultimately, I think that means a technical recovery has taken form, even if the underlying fundamentals are suspect.
My hope is for a multi-year recovery – which was my prior baseline before the chances of a double dip increased. A multi-year recovery really should be the baseline outcome in any technical recovery scenario. However, this does not rule out a double dip per Shiller’s definition. In my view, this journey is far from over – as the continued low savings rate in the US and the policy errors on both sides of the Atlantic demonstrate. The shift, like those two previous periods, will take at least a decade to complete.
–What is a double dip recession?, May 2010
Roubini’s conclusions about the budget strike me as on the money. I am less enamoured with the discussion about bond market vigilantes, though (video below).
Here’s what David Rosenberg saw from quotes from Hoover and Obama he published in his Breakfast with Dave piece today:
A long-standing colleague and reader sent this off to me yesterday and it blew me away. Read on:
Obama’s State of the Union:
“Two years after the worst recession most of us have ever known, the stock market has come roaring back. Corporate profits are up. The economy is growing again.”
Herbert Hoover, May 1st 1930, US Chamber of Commerce Meeting:
“While the crash only took place six months ago, I am convinced we have now passed the worst and with continued unity of effort we shall rapidly recover.”
Obama’s State of the Union:
“Thanks to the tax cuts we passed, Americans’ paychecks are a little bigger today. Every business can write off the full cost of the new investments they make this year. These steps, taken by Democrats and Republicans, will grow the economy and add to the more than one million private sector jobs created last year.”
Herbert Hoover, October 22, 1932, campaign speech in Detroit:
“It can be demonstrated that the tide has turned and that the gigantic forces of depression are today in retreat. Our measures and policies have demonstrated their effectiveness. They have preserved the American people from certain chaos. They have preserved a final fortress of stability in the world.”
Obama’s State of the Union:
“But now that the worst of the recession is over…”
Herbert Hoover, June 1930, to a delegation requesting a public works project:
“Gentlemen, you have come sixty days too late. The depression is over.”
Obama’s State of the Union:
“The steps we’ve taken over the last two years may have broken the back of this recession…”
Herbert Hoover, State of the Union, December 6, 1932:
“The unprecedented emergency measures enacted and policies adopted undoubtedly saved the country from economic disaster…”
Is Rosenberg right in seeing these parallels and if so what should President Obama do? You already know what Rosenberg thinks the President should do.