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Spending cuts in the age of de-leveraging

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Itsuo Inouye/AP/File

(Read caption) In this Nov. 20, 2009 file photo, a shopper checks a jacket from a sales rack with a final discount price of 1,900 yen (US$21) at a store in Tokyo, Japan. Some economists fear that the US is heading towards long-term deflation, which crippled the Japanese economy for much of the 1990s with cycles of cuts, deficits and more cuts.

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Paris, France – As we were saying yesterday, there are several schools of thought regarding the present economy.

1) We’re recovering… (Geithner, Summers, et al)
2) We’re not recovering…we’re headed into inflation (Faber, Stansberry, Casey)
3) We’re not recovering…we’re headed into hard-core deflation (Prechter, Shilling)

And then, there’s the solitary Daily Reckoning home-school view:

We’re not recovering…we’re headed into soft-core, Japanese-style deflation.

Who’s right?

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 – more or less – once or twice in the intervening years. After the big build-up of debt in the mid-00s, we didn’t think the US could afford a long, soft, slow de-leveraging a la Japan. The Japanese had savings…and a positive trade balance. They could afford an order on-again, off-again recession…while their government squandered the savings of an entire generation.

But the US has a huge negative trade balance…and little in the way of savings. How could it survive a Japan-style slump?

Well, things evolve…and our views evolve with them… And in this case, they’ve evolved right back to where they were in the first place. Savings rates are going up. Most other governments – other than the USA – are making an effort to reduce their reliance on borrowing. This leaves enough money available to finance US deficits – not indefinitely, but perhaps for a year or two more…maybe even for 5 or 10 years.

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Could we be wrong about this? You bet. Should you bet your future on it? No sirreee…

But we’re probably right…

The following item will seem like we’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 – people.

You’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)…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 you’d expect). And the immigrants began to go home.

Along with the immigrants were many native-born Irish too,

Yes, “The Irish Exodus” has resumed, reports The Globe and Mail.

“Hundreds of thousands of immigrants used to flock to Ireland, looking for work at the door of Europe’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.”

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.

Where are they going? Canada. New Zealand. Australia. No mention was made of the USA.

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 banks…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 hasn’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 go…but that’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 – which increases the deficit…

You end up with a vicious cycle of cuts, deficits and more cuts…which doesn’t worry us…but the feds don’t like it. And the public doesn’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 – which will have to be repaid sometime. You are also wasting resources – forever – making people absolutely poorer than they otherwise would be.

But we’re going to let it slide this morning.

The point we are reaching for is that de-leveraging isn’t easy. It’s like growing old. That’s not easy either. Still, it’s better than the alternative.

And as for which of the views is correct – recovery, inflation, hard deflation or soft deflation – we’ll just have to wait to find out.

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