05.31.2010 0

Overstimulated

  • On: 06/13/2010 22:31:14
  • In: Economy
  • By Robert Romano

    The Keynesian worldview is unraveling at a remarkable pace, even as Washington desperately cleaves to its once-vaunted borrow-and-spend philosophy to “stimulating” the economy out of recession.

    On June 4th, former Clinton Labor Secretary Robert Reich warned that the nation is “falling into a double-dip recession,” but he does not blame overstimulus or too much government debt, which is weighing down Europe and threatens the U.S. with a serious credit rating downgrade. Instead, he believes that Congress has not spent enough.

    To prevent the next dip, Reich proposes “more stimulus — especially extended unemployment benefits and aid to state and local governments that are whacking schools and social services because they can’t run deficits.” There, Reich is referring to a proposed $23 billion bailout of insolvent states like New York and California that cannot afford to keep their public employees, and a $40 billion extension of unemployment welfare benefits.

    The further along the failed “stimulus” experiment proceeds, and the more obvious the insolvency crisis faced by governments becomes, the more absurd Reich’s Keynesian approach appears to a public already weary of bailouts. That is important because it is voters who will be asked to render their verdicts on the policy’s success in November.

    And right now, the question is not if “stimulus” has failed, but why it has failed.

    It all goes back to the original root of the problem. The current recession was brought about because of too much debt in housing, mortgage-backed securities, and derivatives. This was most obvious with those firms that had become overleveraged on the housing bubble that, when it popped, began a frantic musical chairs approach to restoring solvency to balance sheets.

    Governments responded by incurring much of those debts. In the U.S., AIG’s derivatives contracts were honored by the government. The Federal Reserve purchased about $1.25 trillion in the toxic mortgage-backed securities. Congress spent hundreds of billions of dollars on foreclosure “prevention”. Plus, mortgage giants Fannie Mae and Freddie Mac, and thus housing finance, were nationalized.

    This did not solve the debt problem. It did not even prevent the recession. It merely transferred those liabilities to taxpayers, who have been simultaneously asked to eat roughly $3 trillion in new debt since September 30th, 2008 as the debt has grown to $13 trillion. Throw in more than doubling the money supply by the Federal Reserve since the crisis began in 2007, and nobody can argue with a straight face that the attempts at fiscal and monetary “stimulus” have not been robust.

    Now, all of that new debt realistically threatens the prospects of a sustained recovery with a much graver problem: sovereign default. Therefore, more debt, more lending, and more borrowing are not the solution. And yet, that’s exactly what the Keynesians propose.

    Investors are already demanding a higher premium in return for lending to profligate governments. For example, since November, long-term interest rates are steadily rising in troubled sovereigns Greece, Spain, and Portugal, all threatened with default. In Greece, the rate has moved from 4.84 percent to 7.97 percent. In Spain, from 3.79 percent to 4.08 percent. And in Portugal, from 3.8 to 5.02 percent.

    These are strong indicators of the growing risks associated with legislatures spending too much money, whether on “stimulus,” public education, pensions, unemployment welfare benefits, or health care. They also warn of what may come to pass in advanced economies like the U.S., the UK, and others should their fiscal houses not be brought into order.

    Remarkably, the only incentive for continuing with the failed “stimulus” program is not economic — since it’s not working — but political, and even there its clout is waning. According to Rasmussen Reports, 53 percent of likely voters believe that cutting government spending would be good for the economy. Only 24 percent think it would be bad.

    In fact, nobody really knows what would happen. Since the national debt has grown every single year since 1958 — that’s 52 years for appropriators who have forgotten where the subtract button is on their calculators — actually cutting spending at the federal level is as theoretical as a flat tax, or a manned mission to Mars.

    Perhaps that’s why politicians don’t try it, nor will they try it until they stop viewing the current recession as a failure of not spending enough money. Anna Schwartz, Milton Friedman’s co-author on Monetary History, diagnosed the problem in 2008 when she said of government interventions into the financial crisis: “The Fed has gone about as if the problem is a shortage of liquidity. That is not the basic problem. The basic problem for the markets is that [uncertainty] that the balance sheets of financial firms are credible.”

    Now, that problem has been compounded into market uncertainty about whether the balance sheets of governments are at all credible. We’re overstimulated. The solution, of course, is to begin the long process of paying off the national debt, cutting spending, and rolling back the Keynesian entitlement state — before it’s too late.

    Robert Romano is the Senior Editor of ALG News Bureau.


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