Paul Krugman today ripped into the British Government’s efforts to get the country’s economy back on track, calling austerity fundamentally mad. As one of the world’s most prominent Keynsians I am not surprised, but as a rational thinker I am deeply disturbed.
IMF Managing Director Christine Lagarde has also expressed her reservations regarding deep government cuts. And yet profligate spending policies without corresponding balance have drained government coffers around the world and we are standing on the edge of a deeper crisis than in 2007 based upon exactly the economic policies so strongly advocated by Mr. Krugman. The fundamental rule that at some point governments run out of other peoples money has still not sunk in.
John Maynard Keynes was reacting to the Great Depression when he formulated his policies and they began to be implemented. His work on government stimulus assumed that structural deficits were acceptable in the short-term but did not address a long-term in some cases running for decades with interest compounding along the way.
The postwar economic boom funded the extension of the social welfare state. Huge and incredibly expensive promises were made that Mr. Keynes would not have comprehended. Keynes argued that nations avoid deflation even at the cost of allowing their currency to depreciate in order to keep internal prices stable.
But now we are faced with core commodity inflation. There simply are not enough resources to go around. There are deep structural changes occurring in the global economy.
Both the ECB and Federal Reserve have been running the printing presses at an accelerating rate which has set off the first salvos of currency wars. Mr. Krugman and respectfully, Ms. Lagarde have also failed to note the results of expansive monetary policy and public spending in their host country. The Yen continued to rise in value from the ¥180/$ level of the early 90’s to ¥78/$ today, making their economy uncompetitive. The massive shift of manufacturing in China partially driven by the currency shift not only in Japan but elsewher has also had a deep impact on the pillars of the global economy.
Since the early 1990’s after the Japanese banking collapse, that government has engaged in a Keynsian stimulus program aimed at reviving the economy. The Great Tohoku Earthquake was in many ways another Keynsian economic event, but the result has still been deeply damaging economically. Imports are cheap, but there are no jobs and the debt burden of the Japanese government is growing, not shrinking.
Japanese national debt as a percentage of GDP is the highest in the world with the United States and the UK right behind. This is financed primarily by Japanese savings, which mitigates the damage somewhat, but the reality is that the government is still teetering on the edge of its own abyss, but simply owed to its rapidly aging citizens, who are now putting an even greater strain on retirement funds.
The horrific debt of the United States was one of the other primary topics of the IMF meeting.
While Keynes argued for government spending to even out the depths of financial crises, the constant reliance by modern governments on public debt not only creates the environment in which we find ourselves, but sucks the oxygen from private capital markets where the real engines of growth reside.
Krugman has been hectoring world leaders for more stimulus for the past year just as he has ignored the economic realities staring him right in the face. The bill must eventually be settled and government does not create value; it simply redistributes and regulates economic activity.
He has gotten the stimulus he sought in the world’s two largest economies; Europe and America. But he seems to have forgotten the study of history. Massive stimulus is a very limited weapon with unintended consequences.
The news out of this weekend’s Tokyo meeting is not good. There are many brushfires in the global economy and the tinder for a major economic event is very dry. Every night I pray for some answer, for if we do not find new answers, we are doomed to repeat the past.