June 27, 2013

Two Very Bad Scenario Planning Data Points

Patrick Marren
Partner

Two articles today show that budget-cutting and lack of monetary stimulus may be casting a dark shadow over the future of both the world economy and the local and state economies of the United States. 

First, Ireland, which has uncomplainingly submitted to every demand made upon it by the European Central Bank, has once again fallen into recession. Ireland has been raised numerous times as evidence for the wisdom of the harsh austerity measures imposed on "wayward" European economies by the virtuous northern/central European titans. 

To compare the reactions of the Greeks and the Irish to these demands, just read Michael Lewis' book Boomerang. The Greeks hit the streets and screamed and burned buildings, and got a slightly better deal out of the EU as a result, after several painful renegotiations. The Irish protest, according to Lewis, consisted of a single man who threw one egg at one government official, after the Irish government had promised the EU (and German banks that would have otherwise failed) that the taxpayers of Ireland would make good, 100 cents on the dollar, every debt of Irish banks. 

The Greeks are suffering, all right. But their government had lied to them and had, unlike the Irish (and Spanish) government, actually spent ridiculously beyond its means. But the Irish are getting almost nothing for their suffering. Iceland appears to have done it right: it allowed its banks to collapse and, having preserved its own currency, was able to rebound from far worse debt than even the Greeks'. 

But the beatings, for the Irish, are set to continue. There is zero reason to believe that they are even considering opting out of the euro, or even using that prospect to negotiate a better deal with the EU. 

Meanwhile, closer to home, Illinois (among many other states) is facing a Greece-like collapse, thanks mostly to its own profligacy, but exacerbated by increasing austerity from both the fiscal and monetary policies of the federal government. 

Interest rates are rising, thanks in the short term to the statement of Ben Bernanke last week that he was no longer going to provide quantitative easing to prop up the economy. Bernanke continues to call for fiscal stimulus, but he must know that that will never happen with a Republican Congress standing in the way and an Obama White House that compares the federal government to a household ("After all, small businesses and families are tightening their belts. Their government should, too"). 

The standard, Paul Samuelson, Economics 101 approach to economic stagnation is for the federal government to spend. The United States has not actually done this on a scale approaching what many economists said was needed at the time (January 2009). The federal stimulus of 2009-10 was essentially canceled out by state and local government spending cuts. The subsequent lack of a robust recovery was predictable.

But worse may be in store. U.S. infrastructure has been crumbling; it must be fixed and it will be fixed. But it should have been fixed when the real interest rate paid by the U.S. federal government on its paper was essentially zero. Now that interest rates are rising, we will still have to fix that infrastructure; but future generations of Americans may have to pay multiples of what they would otherwise have paid for those fixes. And in a very real sense, they will pay an even higher price, because an adequate stimulus in 2009 might well have put the economy back in high gear, making all these problems far less pressing.

Make no mistake, we are better off than Europe. But we are only better off than Europe because we spent more and used austerity less. Bernanke's white flag means that, unless policies change markedly in a way we have no reason to think they will, austerity is coming to the United States. Moralizing and economics make terrible policy bedfellows. Illinoisans and Greeks may "deserve" to suffer for their profligacy. But Kansans and Germans WILL suffer if they attempt to punish Chicagoans and Athenians. Hateful as the idea may be to many, we are all in this together. 

Worse, austerity means what economists call "hysteresis": a shadow cast on our economic future, a diminishment of our future potential GDP. Closed schools; lack of investment; lack of innovation; lack of jobs; blighted lives and blighted prospects for American youth. 

The War on the Future continues. 

Comments  | 

pmarren
One other comment: to those who believe that borrowing cannot be good either morally or economically, that argument applies just as well to ANY borrowing by private citizens at ANY time. Once you realize that borrowing can be a good thing for both the individual and the entire economy and society, because it builds wealth and increases economic activity and increases future prospects for everyone, then it becomes impossible to simply rule out, out of hand, borrowing to get an economy in the doldrums back onto a more vigorous track. Our entire economy is essentially based on everyone "living beyond their means." The only questions are how far beyond our means, and under what borrowing conditions, and what we borrow the money for.

Thoughts?