Why government spending won't stave off a correction
Baltimore, Maryland 鈥� I like to work, I鈥檓 rolling all the time鈥�
I can pop my initials on a mule鈥檚 behind鈥�
鈥� Jimmy Rogers
The Dow dropped another 115 points yesterday. Gold moved up to near an all-time high.
This past weekend, we worked on a barn roof鈥ust like we did 30 years ago. But come Monday morning we didn鈥檛 feel 30 years old. Our legs still ached from the weekend鈥檚 work.
We always liked physical labor. Outside in the fresh air. Our feet on the ground鈥ur muscles straining鈥� Concentrating our whole mind on a problem that we can solve! Such as how to get a piece of tin on top of a barn without it taking off in the breeze, like a kite. Or how to get the blades off a bush hog, so they can be sharpened. Or how to set up scaffold on a hill so it doesn鈥檛 fall down.
Simple? Yes鈥nd satisfying.
Man spent millions of years solving practical problems. He needed shelter. He needed food. He needed to fend off predators鈥r he鈥檇 be food!
His mind evolved as a problem-solving machine. Tying things together鈥utting鈥hrowing鈥arrying. He was a mathematician without numbers鈥 climatologist without a thermometer鈥 geographer without a map. He was a practical man who needed to solve practical problems. His life depended on it. And that鈥檚 why he鈥檚 so good at it. He can build trains that go 400 kilometers per hour and pyramids that stand stock still.
Maybe that鈥檚 why we like working with our hands. We were made for it.
But never in 10 million years has any creature solved the problem of a funky, junky economy. It is only in the last 100 years that man has dared to try.
Yes, dear reader, now our leaders are called upon to solve problems that they are not equipped to solve. They are not prepared for the challenge. They cannot do it. Even the best minds in the world are stumped.
The latest important news came out on Friday. Eighteen months. Two trillion dollars. And now this: the number of unemployed people is still going up!
The unemployment rate is creeping back towards 10%. But that only counts the people who have looked for a job in the last year. Trouble is, more and more people have given up looking. The number of people who have been unemployed for 6 months or more has doubled from 3.2 million to 6.7 million. There are now more than 8 million people officially unemployed. And there are millions more unofficially unemployed 鈥� 17% of the population all together.
And even those who have jobs are losing income. That鈥檚 right. With so many people jobless, it doesn鈥檛 make sense to raise wages; instead, wages are going down. Supply up, prices down.
All of these facts are consistent with a Great Correction. They are what we expected. They are merely things happening they way they ought to happen.
But these events are not compatible with the pretensions of the economic world improvers. Tim Geithner, for example. The poor man is frustrated by his European counterparts. While he and his colleagues in the US continue to stimulate the economy in order to make the world a better place鈥he Europeans have decided to get their financial houses in order. And that means cutbacks in public spending. To give you just a hint of what is going on, here鈥檚 a Bloomberg report:
Cameron Prepares UK for Cuts Hurting 鈥楨very Single Person鈥�
June 7 (Bloomberg) 鈥� UK Prime Minister David Cameron, preparing voters for the deepest spending cuts in a generation, said the previous Labour government left the public finances in a weaker state than he anticipated.
鈥淭he overall scale of the problem is even worse than we thought,鈥� Cameron said in a speech today in Milton Keynes, 50 miles (80 kilometers) north of London. 鈥淭he decisions we make will affect every single person in our country. And the effects of those decisions will stay with us for years, perhaps decades to come.
鈥淭oday we spend more on debt interest than we do on running schools in England,鈥� Cameron said.
鈥淩aising taxes and cutting spending is socially painful. But what鈥檚 the alternative, keeping generous budget policies?鈥� Nouriel Roubini, the New York University economist who predicted the financial crisis, said in an interview with Le Monde. 鈥淭he markets have already sounded the alarm that continuing that way would lead to bankruptcy,鈥� he said. 鈥淎usterity isn鈥檛 optional.鈥�
What has happened in Britain is little different from what has happened everywhere else in the developed world.
鈥淔orty years ago,鈥� said an Englishman on the phone yesterday, 鈥淏ritain had 8 million people in manufacturing, making things, and 3 million people on the public payroll, consuming them. Now, those numbers have almost completely reversed. And it gets worse. Every day, 126 people are added to government employment in Britain, while 1440 private sector jobs are eliminated.鈥�
Germany is promising cuts to government spending too. Bloomberg again:
鈥淢erkel鈥檚 cabinet backs decisive cuts鈥︹��
The way we look at it here at The Daily Reckoning is this: the world improvers have made a massive mistake. They鈥檝e spent too much money鈥nd put too much of the economy under control of the government. Now, the markets 鈥� and economic reality 鈥� are forcing a correction.
But many economists see no mistake and think austerity IS optional. Paul Krugman, for example. Like Mr. Geithner, The New York Times columnist thinks it鈥檚 just a matter of better management. He thinks the government should increase spending in a downturn 鈥� even if the government hasn鈥檛 got any money:
鈥淭he right thing, overwhelmingly, is to do things that will reduce spending and/or raise revenue after the economy has recovered 鈥� specifically, wait until after the economy is strong enough that monetary policy can offset the contractionary effects of fiscal austerity. But no: the deficit hawks want their cuts while unemployment rates are still at near-record highs and monetary policy is still hard up against the zero bound.鈥�
In other words, Krugman believes that overspending on government-led consumption is not the problem. Instead, the problem is the correction itself. Once the correction is stopped 鈥� by more government spending! 鈥� then, the feds can cut back.
The important thing about putting on roofing is that you have to work from the bottom up. The upper pieces have to overlap the bottom pieces so that water runs off the roof.
Probably neither Geithner nor Krugman has ever put on a roof. If they had, maybe they鈥檇 have a greater appreciation for the practical side of things. Deficit hawks do not put the roofing on from the bottom up just because they are grumpy and have low levels of sugar in their blood. They do it because it is the practical, sensible solution to the problem of credit quality. If you want people to lend you money, you have to be able to pay your bills.
Krugman鈥檚 solution is deeply impractical, to the point of absurdity. He proposes that the feds spend money they don鈥檛 have to cure the problems caused by spending money they didn鈥檛 have. It鈥檚 like starting the roofing at the peak of the roof. It will look like a roof. It just won鈥檛 shed water.
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