05.25.2010 0

A Keynesian Paradox

By Robert Romano

The threat of a double-dip recession is real, but it should not be cause for more government “stimulus,” deficit-spending, bailouts, and low-interest monetary easing. The primary reason for the current market downturn is unacceptably high levels of sovereign debt and spending in Europe, the U.S., Japan, and elsewhere.

This poses a Keynesian paradox, defying Keynes’ essential proposition that in a recession, governments must engage in deficit-spending in the absence of private investment. Only, when the economic downturn began in 2007, that’s exactly what Western economies did. Now, they’re going broke, creating more dislocation in the markets — which the deficit-spending was supposed to cure.

Hence the paradox. The deficit-spending promised to bring the economy around, but instead it put too much pressure on government balance sheets, and now the global economy is suffering badly as a result.

The recession continues and unemployment remains high in spite of continued government interventions here in the U.S. It was not long ago that the Obama Administration was using last year’s stock market recovery as evidence that the “stimulus” was “working.” But with the Dow Jones Industrial Average down about 3.46 percent this year, unemployment plateaued at an uncomfortably high 10 percent, and gold startlingly elevated at nearly $1,200 an ounce — a strong indication of inflation on the horizon — where is this fabled sustainable recovery?

To date, monetary and fiscal expansions have created false market indicators, including artificial demand for mortgage-backed securities, real estate, U.S. treasuries, higher education spending, and other government-subsidized “assets.” Really, this is just artificial demand for debt, and it is therefore unsurprising that the costs of debt are now rising for troubled sovereigns like Greece, Portugal, the UK and others.

This is what happens when the priming pump breaks. Water just leaks out — and becomes more expensive to sop up.

This week, Congress is due to add more pressure to the $13 trillion national debt by considering a $12 billion extension of unemployment welfare benefits once again. That’s included in a $174 billion spending bill, as scored by the Congressional Budget Office. The Senate is also considering spending another $23 billion bailout of increasingly insolvent states like New York and California.

That’s nearly $200 billion in new spending being proposed — just this week. All of which will be piled atop the national debt. As if that will help what is essentially an insolvency crisis faced by governments. All told, Barack Obama plans on adding another $10.6 trillion to the debt this decade alone. During that same period, interest rates will rise dramatically, as will the costs of servicing that debt. By 2020, the CBO projects that the annual interest owed on the debt will rise to $920 billion.

The nation cannot afford it — no nation could — and the markets know it.

The important lesson here is that a double-dip recession was entirely avoidable when the ultimate threat to the economy after the recession and trillion-dollar bailouts began was the government overspending. But since the binge has already begun, the danger now is that the Keynesians will conclude that government has not yet binged enough.

“We didn’t spend enough,” will be their only logical conclusion should the economy dip again, leading to another spending, borrowing, and money-printing spree. This will form the foundation for further insolvency, causing markets to scatter, and ultimately lead to an even-more sustained downturn — otherwise known as a depression.

There is still time to reverse this suicidal trend, but it will take strong leadership to turn the pump off, sop up the easy money, cut spending significantly, and allow failed institutions to fail by bringing an end to bailouts. Ronald Reagan did it once in the 1980’s by hardening the currency, and both unemployment and inflation were eventually slashed. An unprecedented economic boom began, the fruits of which will now rot through if somebody doesn’t turn the water off.

Robert Romano is the Senior Editor of ALG News Bureau.

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