01.14.2013 0

The true ‘conservatives’

By Bill Wilson Gross Domestic Product (GDP) forecasts are coming in for the fourth quarter, and they are not good news for the economy — and foretell another hard year for the 22.4 million people struggling to find full-time work, and the 5 million who have simply given up all together.

Due to a sharp increase in imports, which are subtracted from the GDP, and just a modest increase in exports, Wall Street firms are downgrading their estimate for growth, reports Zerohedge.com. Goldman Sachs predicts 1.3 percent real growth, JP Morgan 0.8 percent, Royal Bank of Scotland 0.7 percent, and Nomura 1.3 percent.

That’s not good. Fourth quarters have usually done pretty well during Obama’s term of office: 4 percent annualized growth in 2009, 2.4 percent in 2010, and 4.1 percent in 2011. In many ways they have been his saving grace.

So, something’s wrong. The economy appears to be in the midst of another slowdown.

We will have more information when the Bureau of Economic Analysis (BEA) produces its advance estimate for the fourth quarter on Jan. 30, but in the meantime, there appears to be little reason to doubt the estimates after a poor Christmas shopping season.

All of which gives the Obama Administration little reason to celebrate its second inaugural, as Obama’s new term of office appears poised to produce little growth — except of course in the national debt, which should be a cool $20 trillion by the time he’s done in 2016.

If even the most optimistic Wall Street estimate proves correct — 1.3 percent growth in the fourth quarter — real growth for all of 2012 will come in at just 1.9 percent.

But why? Why, four years after the financial crisis, and after trillions of dollars of fiscal and monetary “stimulus,” is the economy still seemingly dead in the water?

Narayana Kocherlakota, president of the Minneapolis Federal Reserve, thinks he knows. There was not enough “stimulus.”

At a meeting sponsored by the Minneapolis Fed, Kocherlakota said, “Inflation will run below the Fed’s target of 2 percent over the next two years and the unemployment rate will remain elevated. This forecast suggests that, if anything, monetary policy is currently too tight, not too easy.”

That certainly runs parallel to what New York Times pundit Paul Krugman has been saying for four years now. In a recent interview with Rolling Stone, Krugman expressed his frustration: “When the stimulus was being promoted and discussed, I was very publicly tearing my hair out, saying this is way inadequate. And sure enough, it was.”

At the time, in 2009, Krugman suggested the $800 billion “stimulus” under consideration was far too small. He wanted something closer to $2 trillion.

So, let us analyze this claim with an open mind. Has government deficit-spending and monetary expansion actually been insufficient to foster the robust economic recovery everyone was hoping for after the crisis?

Previously, Americans for Limited Government has undertaken an analysis of gross debt outstanding in the U.S. — all debts public and private — as measured by the Federal Reserve, and examined its relationship with economic growth.

Beginning in 1945 all the way through 1970, the relationship of total debt to GDP remained relatively constant.  True, there were variations.  But debt to GDP remained inside a narrow range of 140 percent to 160 percent.

There was another relationship that was pretty constant as well.  For every additional unit of debt we incurred, we saw an equal or greater expansion of GDP — as debt grew the underlying economy grew at an equal or greater amount.

From 1945-1950, nominal GDP grew at 31 percent versus debt expansion of 20 percent.  From 1950-1955, the economy grew 42 percent and debt 37 percent.  And from 1965-1970, GDP expanded 56 percent while debt grew at 44 percent. During those days, credit expansion was predicated on economic growth.

But after 1971, when Richard Nixon took the nation off the last semblance of the gold standard, that relationship broke down. Yes, there were periods in history when the economy grew faster than the nation’s total debt — but they were all before 1971.

From 1970-1980, nominal GDP grew at 168 percent and debt at a whopping 195 percent. From 1980-1990, the economy grew at 108 percent and debt 191 percent. From 1990-2000, GDP expanded 71 percent while debt grew by 97 percent. And from 2000-2010, the economy grew 43 percent while debt increased 96 percent.

By then, debt to GDP was 367 percent.

So, the dollar-of-new-debt-equaling-a-dollar-of-new-growth relationship has been turned on its head. Now it takes $2 of debt for every dollar of growth we experience, a relationship that has remained constant even during the economic slowdown.

From the third quarter of 2011 through 2012, the economy expanded nominally by $647.8 billion. Debt during that same period expanded $1.227 trillion.

That may sound like a lot, but the fact is that to keep pace with previous decades when debt doubled every 10 years, the current $55 trillion of credit outstanding will also need to double, growing by about $5 trillion annually, not $1 trillion.

Sound crazy? Yes, it is. But, if we are to follow the statistical model that Krugman, et al. have called for, that is what would have to do be done — and right now there is not nearly enough new debt to juice the economy at the rate it once did.

The question is why. While some have wanted to suggest that the banks are not lending, the reality is that people and businesses are not borrowing — i.e. demand for credit is low. Which is understandable. The American people have already maxed out their credit cards. They already have mortgages and mountains of student loan debt.

The government is already borrowing more than $1 trillion a year. It cannot spend fast enough to grow total debt by $5 trillion a year. And even if it tried, we would be left with Treasury debt larger than could be refinanced, let alone be repaid, over the long run.

Not even Ben Bernanke has the guts to try to expand the Fed’s balance sheet that rapidly. His commitment for QE3 and QE4 is just $1 trillion a year.

The simple fact is that there are not enough people to accept the necessary increase in debt — because it is unsustainable. This Ponzi system of finance hit its natural limitation in 2008.

Since then, the necessary process of deleveraging and balance sheet repair has been underway, particularly in the financial sector — which has seen net liabilities shrink every single year since 2008 from $17.1 trillion to $13.7 trillion today.

So, we could follow Krugman and Kochlerlakota’s “impeccable” logic — into the Abyss. They are the true “conservatives,” the defenders of a status quo that has stood for over 80 years. The problem is that it is no longer working.

Bill Wilson is the President of Americans for Limited Government. You can follow Bill on Twitter at @BillWilsonALG.

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