Spending cuts in the age of de-leveraging(Read article summary)
The US has a huge negative trade balance and little in the way of savings. Could it survive a Japan-style slump?
Paris, France â€“ As we were saying yesterday, there are several schools of thought regarding the present economy.
1) Weâ€™re recoveringâ€¦ (Geithner, Summers, et al)
2) Weâ€™re not recoveringâ€¦weâ€™re headed into inflation (Faber, Stansberry, Casey)
3) Weâ€™re not recoveringâ€¦weâ€™re headed into hard-core deflation (Prechter, Shilling)
And then, thereâ€™s the solitary Daily Reckoning home-school view:
Weâ€™re not recoveringâ€¦weâ€™re headed into soft-core, Japanese-style deflation.
You will recognize our point of view as the same thing we were saying 10 years ago. Of course, we changed our mind about it â€“ more or less â€“ once or twice in the intervening years. After the big build-up of debt in the mid-00s, we didnâ€™t think the US could afford a long, soft, slow de-leveraging a la Japan. The Japanese had savingsâ€¦and a positive trade balance. They could afford an order on-again, off-again recessionâ€¦while their government squandered the savings of an entire generation.
But the US has a huge negative trade balanceâ€¦and little in the way of savings. How could it survive a Japan-style slump?
Well, things evolveâ€¦and our views evolve with themâ€¦ And in this case, theyâ€™ve evolved right back to where they were in the first place. Savings rates are going up. Most other governments â€“ other than the USA â€“ are making an effort to reduce their reliance on borrowing. This leaves enough money available to finance US deficits â€“ not indefinitely, but perhaps for a year or two moreâ€¦maybe even for 5 or 10 years.
Could we be wrong about this? You bet. Should you bet your future on it? No sirreeeâ€¦
But weâ€™re probably rightâ€¦
The following item will seem like weâ€™re changing the subject. Au contraire. It was reported in The Globe and Mail that the Irish have gone back to exporting what they export best â€“ people.
Youâ€™ll recall that the late, much-regretted boom had completely transformed the Emerald Isle. All of a sudden, the Irish were the richest people in Europe (based on the value of their houses, mostly)â€¦and hundreds of thousands of Poles and other immigrants were streaming into Ireland in order to find work.
Practically all the waitresses and barmaids in Dublin seemed to have an Eastern European accent. And there was even a Polish-language TV station. Can you believe it?
But then came the bust. Suddenly, the Irish had to come back down to the bog. The jobs disappeared. Housing prices fell (though not yet as much as youâ€™d expect). And the immigrants began to go home.
Along with the immigrants were many native-born Irish too,
Yes, â€śThe Irish Exodusâ€ť has resumed, reports The Globe and Mail.
â€śHundreds of thousands of immigrants used to flock to Ireland, looking for work at the door of Europeâ€™s strongest economy. But after two decades and a stunning collapse, Ireland is once again a nation of emigrants, seeking employment elsewhere to escape the sad reality at home.â€ť
Oh well, it was bad while it lasted. Now, the Irish can give up property development and go back to poetry and alcohol. The country may not be as prosperous, but it will surely be prettier.
Seventy thousand people are expected to leave the island this year. By 2015, the total is expected to rise to 200,000, if unemployment trends continue.
But what is most interesting to us is the story behind the story. Ireland is not only the European nation the farthest out to the West. It is also the one the farthest out in front in the fight against deficit spending. While others dilly-dallied, Ireland cut. It bailed out its big banksâ€¦and then had to protect its own credit. But despite deep cuts, the deficit remains stubbornly high. At 11% it is in line with the US, which hasnâ€™t made any effort to cut at all.
What went wrong?
It appears that the neo-Keynesians Krugman and Wolf are right about at least one thing. Cutting government spending while the private sector is de-leveraging is a hard way to go. (In our opinion, it is the right way to goâ€¦but thatâ€™s another issue!)
What happens is that as the feds cut back it reduces income to the private sector, which is itself in cutback mode. This then causes tax revenues to fall â€“ which increases the deficitâ€¦
You end up with a vicious cycle of cuts, deficits and more cutsâ€¦which doesnâ€™t worry usâ€¦but the feds donâ€™t like it. And the public doesnâ€™t care for it much either. Better to wait until the private sector has finished de-leveraging, say most experts.
Of course, then you are only building up public sector debt â€“ which will have to be repaid sometime. You are also wasting resources â€“ forever â€“ making people absolutely poorer than they otherwise would be.
But weâ€™re going to let it slide this morning.
The point we are reaching for is that de-leveraging isnâ€™t easy. Itâ€™s like growing old. Thatâ€™s not easy either. Still, itâ€™s better than the alternative.
And as for which of the views is correct â€“ recovery, inflation, hard deflation or soft deflation â€“ weâ€™ll just have to wait to find out.
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