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Why government spending won't stave off a correction

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Seth Wenig/AP/File

(Read caption) In this May 27 photo, trader Kevin K. Lodewick works on the floor at the New York Stock Exchange in New York. The Dow dropped another 115 points on Monday.

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Baltimore, MarylandI like to work, I’m rolling all the time…
I can pop my initials on a mule’s behind…

– Jimmy Rogers

The Dow dropped another 115 points yesterday. Gold moved up to near an all-time high.

This past weekend, we worked on a barn roof…just like we did 30 years ago. But come Monday morning we didn’t feel 30 years old. Our legs still ached from the weekend’s work.

We always liked physical labor. Outside in the fresh air. Our feet on the ground…our muscles straining… Concentrating our whole mind on a problem that we can solve! Such as how to get a piece of tin on top of a barn without it taking off in the breeze, like a kite. Or how to get the blades off a bush hog, so they can be sharpened. Or how to set up scaffold on a hill so it doesn’t fall down.

Simple? Yes…and satisfying.

Man spent millions of years solving practical problems. He needed shelter. He needed food. He needed to fend off predators…or he’d be food!

His mind evolved as a problem-solving machine. Tying things together…cutting…throwing…carrying. He was a mathematician without numbers…a climatologist without a thermometer…a geographer without a map. He was a practical man who needed to solve practical problems. His life depended on it. And that’s why he’s so good at it. He can build trains that go 400 kilometers per hour and pyramids that stand stock still.

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Maybe that’s why we like working with our hands. We were made for it.

But never in 10 million years has any creature solved the problem of a funky, junky economy. It is only in the last 100 years that man has dared to try.

Yes, dear reader, now our leaders are called upon to solve problems that they are not equipped to solve. They are not prepared for the challenge. They cannot do it. Even the best minds in the world are stumped.

The latest important news came out on Friday. Eighteen months. Two trillion dollars. And now this: the number of unemployed people is still going up!

The unemployment rate is creeping back towards 10%. But that only counts the people who have looked for a job in the last year. Trouble is, more and more people have given up looking. The number of people who have been unemployed for 6 months or more has doubled from 3.2 million to 6.7 million. There are now more than 8 million people officially unemployed. And there are millions more unofficially unemployed – 17% of the population all together.

And even those who have jobs are losing income. That’s right. With so many people jobless, it doesn’t make sense to raise wages; instead, wages are going down. Supply up, prices down.

All of these facts are consistent with a Great Correction. They are what we expected. They are merely things happening they way they ought to happen.

But these events are not compatible with the pretensions of the economic world improvers. Tim Geithner, for example. The poor man is frustrated by his European counterparts. While he and his colleagues in the US continue to stimulate the economy in order to make the world a better place…the Europeans have decided to get their financial houses in order. And that means cutbacks in public spending. To give you just a hint of what is going on, here’s a Bloomberg report:

Cameron Prepares UK for Cuts Hurting ‘Every Single Person’

June 7 (Bloomberg) – UK Prime Minister David Cameron, preparing voters for the deepest spending cuts in a generation, said the previous Labour government left the public finances in a weaker state than he anticipated.

“The overall scale of the problem is even worse than we thought,” Cameron said in a speech today in Milton Keynes, 50 miles (80 kilometers) north of London. “The decisions we make will affect every single person in our country. And the effects of those decisions will stay with us for years, perhaps decades to come.

“Today we spend more on debt interest than we do on running schools in England,” Cameron said.

“Raising taxes and cutting spending is socially painful. But what’s the alternative, keeping generous budget policies?” Nouriel Roubini, the New York University economist who predicted the financial crisis, said in an interview with Le Monde. “The markets have already sounded the alarm that continuing that way would lead to bankruptcy,” he said. “Austerity isn’t optional.”

What has happened in Britain is little different from what has happened everywhere else in the developed world.

“Forty years ago,” said an Englishman on the phone yesterday, “Britain had 8 million people in manufacturing, making things, and 3 million people on the public payroll, consuming them. Now, those numbers have almost completely reversed. And it gets worse. Every day, 126 people are added to government employment in Britain, while 1440 private sector jobs are eliminated.”

Germany is promising cuts to government spending too. Bloomberg again:

“Merkel’s cabinet backs decisive cuts…”

The way we look at it here at The Daily Reckoning is this: the world improvers have made a massive mistake. They’ve spent too much money…and put too much of the economy under control of the government. Now, the markets – and economic reality – are forcing a correction.

But many economists see no mistake and think austerity IS optional. Paul Krugman, for example. Like Mr. Geithner, The New York Times columnist thinks it’s just a matter of better management. He thinks the government should increase spending in a downturn – even if the government hasn’t got any money:

“The right thing, overwhelmingly, is to do things that will reduce spending and/or raise revenue after the economy has recovered – specifically, wait until after the economy is strong enough that monetary policy can offset the contractionary effects of fiscal austerity. But no: the deficit hawks want their cuts while unemployment rates are still at near-record highs and monetary policy is still hard up against the zero bound.”

In other words, Krugman believes that overspending on government-led consumption is not the problem. Instead, the problem is the correction itself. Once the correction is stopped – by more government spending! – then, the feds can cut back.

The important thing about putting on roofing is that you have to work from the bottom up. The upper pieces have to overlap the bottom pieces so that water runs off the roof.

Probably neither Geithner nor Krugman has ever put on a roof. If they had, maybe they’d have a greater appreciation for the practical side of things. Deficit hawks do not put the roofing on from the bottom up just because they are grumpy and have low levels of sugar in their blood. They do it because it is the practical, sensible solution to the problem of credit quality. If you want people to lend you money, you have to be able to pay your bills.

Krugman’s solution is deeply impractical, to the point of absurdity. He proposes that the feds spend money they don’t have to cure the problems caused by spending money they didn’t have. It’s like starting the roofing at the peak of the roof. It will look like a roof. It just won’t shed water.

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