Daily commentary: thoughts on austerity as a policy tool and on India as a black swan

The news flow today is about the same as it has been throughout the week: JPMorgan Chase and Facebook in the US and Greece and to a lesser degree now Spain in the EU. I think these are the wrong narratives to be focused on. As I wrote yesterday, I believe China will suffer a hard landing but that India will be worse than China. In my view, the economic slowdown in India is the biggest story that’s not making headlines.

Then there is the debate over austerity. I posted on how we had the same debates about austerity under the gold standard while Hoover was President in the US during the Great Depression (see Hoover on austerity to balance the budget and defend the dollar in 1932). Here’s my view on that debate.

I think Rajan is mostly right when he writes in the FT link on sensible Keynesians below:

the past build-up of debt in now depressed areas may suggest that demand was too high relative to incomes. If so, demand, without the dangerous stimulant of borrowing, will stay weak. Policy should instead help workers move where there are suitable jobs – for instance, by helping them offload their homes and the associated debt without the stigma of default.

As I wrote in the comment section on the Hoover post, I think it’s important to get the historical facts right instead of biasing them through an ideological lens. The Great Depression offers good lessons on this score.

The fact is Hoover was not talking austerity in 1930 and 1931. His budgets for 1930 and 1931 did not have large deficits. Once the bank crisis hit, the 1932 budget was catastrophic and that’s when the austerity rhetoric started. But in the end, he capitulated and as the crisis deepened, we never heard the austerity talk again. Hoover did not veto the spending. He signed off on it.

The right narrative on the Great Depression is that the depression was the result of significant malinvestment that was built up during the 1920s as a result of loose monetary policy at the Fed (see here), much as Rajan argues this malaise has similar antecedents in excess private sector credit growth. The question in the 1930s was how to eliminate the malinvestment and reallocate capital investment to useful productive enterprises without creating a deflationary spiral. When credit is written down, GDP drops and people are thrown out of work. That can be mitigated. It was bank runs that created the deflationary spiral that caused a Great Depression. So the answer is to write down assets and recapitalise the banking system quickly rather than dragging it out.

In the context of bank runs, attempts at austerity made things considerably worse. Austerity is a failed paradigm. The government shouldn’t have wasteful programs to begin with so there should be no need to cut them just to cut a deficit. Moreover, the deficit is the result of an ex-post accounting identity between private savings, and current account and government balances. It makes zero sense to target the effect (deficits) instead of the cause (excess credit growth and malinvestment).

I support targeted stimulus to counteract the fall in demand associated with this downturn. But it is no panacea. Until we have reduced the private indebtedness associated with the credit binge, the economy will be weak. Attempts to revive credit growth will only make matters worse.

China economic picture darkening, warns Brevan Howard – Citywire Money

India’s central bank ‘intervenes’ as rupee hits new low

BBC News – Indian rupee plummets to historic low against dollar

Nick Clegg reveals ‘massive’ infrastructure plans as Coalition hunts growth – Telegraph

100 Million Americans Without Jobs | Crossing Wall Street

Sensible Keynesians see no easy way out – FT.com

Papademos, Grexit, and catastrophe blackmail – Telegraph Blogs

The Samsung Galaxy S III: The First Smartphone Designed Entirely By Lawyers

War-Gaming Greek Euro Exit Shows Hazards in 46-Hour Weekend – Bloomberg

Economists React: What Happens If Greece Leaves Euro Zone? – Real Time Economics – WSJ

What if Spain exits the euro? – elConfidencial.com

Germany borrows at record low rates – FT.com

Sie sind und bleiben der falsche Weg | Institut der deutschen Wirtschaft Köln (IW)

Italiaanse consumenten somberst sinds 1996 – RTL Z

Who could update RIM’s status? Facebook – The Globe and Mail

World Bank trims China growth to 8.2% – FT.com

German Bundesbank warns Greece not to reject reforms | Reuters

El consumo de cemento se desploma un 41,1% en abril hasta niveles de 1966 – Noticias.com

Family’s joy as daughter buys back house taken over by bank – Property & Mortgages, Personal Finance – Independent.ie

Housing and lending risks need to be better monitored in Canada, says ex-Bank of Canada governor Gordon Thiessen | Economy | News | Financial Post

Scotia Plaza: Scotiabank signs deal to sell Toronto headquarters for $1.27-billion to Dundee, H&R REIT | FP Street | News | Financial Post

Merkel und Hollande: Deutsch-französische Irritationen | FTD.de

Greek banks to receive 18-billion-euro bailout: source | Investing | Financial Post

¡¡¡Es necesario subir los ingresos públicos!!! — Nada es Gratis

An $8bn Loss Or Was JPMorgan ‘Unhedged, Long-And-Wrong’ Post-LTRO2? | ZeroHedge

Calm Before the Storm? – Tim Duy’s Fed Watch

Merkel und Hollande: Deutsch-französische Eiszeit | FTD.de

EXCLUSIVE: Here’s The Inside Story Of What Happened On The Facebook IPO – Business Insider

1 Comment
  1. Cap'n Credit says

    so what is your timeframe for the de-leveraging that you prescribe/predict?

    and what aids can the gov’t provide to speed this along (i’m assuming you’re focused on HAMP/HARP/debt forgivness/principal reductions)?

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