08.31.2010 0

Is the Double-Dip Coming?

  • On: 09/16/2010 21:10:56
  • In: Economy
  • By Robert Romano

    Despite unprecedented fiscal and monetary “stimulus,” the global economy may be dipping again. Not just confined to the U.S., the economic slowdown appears to be a worldwide phenomenon, according to the Organization of Economic Cooperation and Development (OECD).

    As the OECD said in its report, “[r]ecent high frequency indicators point to a slowdown in the pace of recovery of the world economy that is somewhat more pronounced than previously anticipated.” The organization predicted that growth in G7 economies could slow to an annualized rate of about 1.5 percent for the remainder of the year.

    This does not bode well, and it could mean that the economy is about to dip again. Peaks in economic growth are often followed by dips. The question is whether the coming dip will simply mean slower growth, or another recession. The report states, “It is not yet clear whether the loss of momentum in the recovery is temporary … or whether it signals greater underlying weaknesses in private spending at a time when policy support is being removed.”

    There, it appears the OECD is hedging its bets. If the slowdown is temporary, then the “stimulus” worked and a full-fledged recovery will get under way soon. If economy dips again, it was because there was not enough spending and printing new money by government, or because the “stimulus” has been rolled back.

    Either way, says the OECD, “stimulus” must be maintained. The OECD proposes either to A) “postpone the withdrawal of monetary support for a few months, while maintaining planned budget consolidation to address unsustainable fiscal positions”; or B) “if the slowdown reflects longer-lasting forces bearing down on activity, additional monetary stimulus might be warranted in the form of quantitative easing and commitment to close-to-zero policy interest rates for a long period. Where public finances permit, planned fiscal consolidation could be delayed.”

    Really, this is just an attempt to downplay the economic viability of making spending cuts or any monetary tightening — ever.

    No where does the OECD appear to consider the hypothesis that the financial crisis was actually caused by too much government-created debt in mortgage markets, and that more debt to “solve” it might be counterproductive. Nor does it appear to consider the severe potential consequences of countries with “unsustainable fiscal positions” delaying “planned fiscal consolidation”.

    It could be disastrous, especially if the principal impediment on economic growth at the moment is indeed sovereign debt. There, the OECD does at least appear to recognize that the inability of governments to repay their debts as a factor hurting growth. According to the OECD, weighing down the economy are: 1) “additional adjustments by households to the balance-sheet losses suffered during the recession”; 2) further home price declines; 3) uncertainty about unemployment; and 4) “uncertainty in sovereign debt markets”.

    Nonetheless, despite all of the obvious signs that the crisis was caused by and compounded by too much debt, the OECD and others now appear ready to declare the biggest problem to be fiscal consolidation. But this is just another new, post hoc explanation for the causes of the financial crisis in the first place.

    Take Paul Krugman, who writes, “Back in May, the OECD was responding to social pressure, not economic logic. All the right people wanted austerity now now now, because, well, because, and the OECD went along. Now a bit of bad economic news has led the organization to look down, and realize that there’s nothing supporting its position. But there never was.”

    Except the sovereign debt crisis. Countries that have overspent are now being held accountable in the bond market. The credit rating agencies are also holding them accountable by downgrading them. Rightly so.

    To be fair, immediate efforts at fiscal consolidation may in fact result in slower growth and higher unemployment in the short term, but that does not mean they should not be undertaken. Sovereign defaults promise to do far more damage than any temporary economic downturn could ever cause.

    Take Ireland as a case study. Some writers, like Bloomberg’s Matthew Lynn, have pointed to Ireland as an example of a nation that has engaged in consolidation, but to no avail. S&P has still downgraded Irish debt despite making cuts, writes Lynn.

    However, despite favorable attention Ireland received when budget cuts were proposed, the government has largely not followed through. Its downgrade really reflects half-measures.

    After its budget peaked at €56.082 billion gross expenditures in 2008, Ireland has only cut down to a proposed €54.940 billion in 2010. It foresees keeping that level of spending indefinitely. Ireland has not “stuck to the rulebook,” as Lynn maintains. The government there just hasn’t done much to cut spending.

    The only reforms to the public pension system appearing in the 2010 budget are: raising the retirement age to 66 from 65; and imposing a max. retirement age of 70; pensions will be derived from a career average instead of final salary; and they’re considering using the Consumer Price Index to calculate post-retirement increases.

    The impact has been minimal. Ireland, despite talk of reforming the public pension system, remains hopelessly tethered to a defined benefit scheme — even for new entrants. In the meantime, it has only cut about €1.2 billion from the budget, despite a deficit of €13.718 billion. Only in 2012 does it expect the deficit to come down, and then only because they expect revenues to rise, not spending to be significantly cut. In fact, overall spending won’t be cut significantly in upcoming budgets.

    The debt has risen from 25 percent of GDP at the end of 2007 to 64.5 percent of GDP at the end of 2009, or €75.2 billion.

    Ireland’s fiscal situation is devolving from bad to worse as it is currently facing a banking crisis. Placing upward pressure on the debt, Ireland is recapitalizing (nationalizing-bailing out) Anglo-Irish Bank with €40 billion in Irish taxpayer funds, according to Fine Gael. This open-ended commitment is akin to the U.S.’ TARP wherein bank losses are heaped atop public debt. Fine Gael estimates that the bank bailouts in Ireland will eventually double the national debt.

    So, by not making the tough decisions to significantly cut spending, Ireland is still risking a Greece-like crisis. The bank bailouts decision made it likely that their national debt will continue to balloon to 100 percent of GDP before the decade ends. So, Ireland has been downgraded because it only made cosmetic cuts which made no serious dent in its debt/deficit-to-GDP ratios.

    The same scenario plays out in the U.S. and anywhere else where government has grown beyond its means. The chief impediment on growth right now is the tremendous footprint government has put into the economy, diverting financing away from the private sector. Not to mention the risk that governments will either default on their obligations, or that monetary authorities will simply print money to make a pretended payment on the debts owed.

    Therefore, the risk to the economy is not fiscal consolidation, as the Krugmaniacs maintain. It’s that efforts at balancing budgets will be half-baked, cosmetic, and fraudulent.

    Robert Romano is the Senior Editor of Americans for Limited Government (ALG) News Bureau.


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