Spending cuts in the age of de-leveraging
The US has a huge negative trade balance and little in the way of savings. Could it survive a Japan-style slump?
In this Nov. 20, 2009 file photo, a shopper checks a jacket from a sales rack with a final discount price of 1,900 yen (US$21) at a store in Tokyo, Japan. Some economists fear that the US is heading towards long-term deflation, which crippled the Japanese economy for much of the 1990s with cycles of cuts, deficits and more cuts.
Itsuo Inouye/AP/File
Paris, France 鈥� As we were saying yesterday, there are several schools of thought regarding the present economy.
1) We鈥檙e recovering鈥� (Geithner, Summers, et al)
2) We鈥檙e not recovering鈥e鈥檙e headed into inflation (Faber, Stansberry, Casey)
3) We鈥檙e not recovering鈥e鈥檙e headed into hard-core deflation (Prechter, Shilling)
And then, there鈥檚 the solitary Daily Reckoning home-school view:
We鈥檙e not recovering鈥e鈥檙e headed into soft-core, Japanese-style deflation.
Who鈥檚 right?
You will recognize our point of view as the same thing we were saying 10 years ago. Of course, we changed our mind about it 鈥� more or less 鈥� once or twice in the intervening years. After the big build-up of debt in the mid-00s, we didn鈥檛 think the US could afford a long, soft, slow de-leveraging a la Japan. The Japanese had savings鈥nd a positive trade balance. They could afford an order on-again, off-again recession鈥hile their government squandered the savings of an entire generation.
But the US has a huge negative trade balance鈥nd little in the way of savings. How could it survive a Japan-style slump?
Well, things evolve鈥nd our views evolve with them鈥� And in this case, they鈥檝e evolved right back to where they were in the first place. Savings rates are going up. Most other governments 鈥� other than the USA 鈥� are making an effort to reduce their reliance on borrowing. This leaves enough money available to finance US deficits 鈥� not indefinitely, but perhaps for a year or two more鈥aybe even for 5 or 10 years.
Could we be wrong about this? You bet. Should you bet your future on it? No sirreee鈥�
But we鈥檙e probably right鈥�
The following item will seem like we鈥檙e changing the subject. Au contraire. It was reported in The Globe and Mail that the Irish have gone back to exporting what they export best 鈥� people.
You鈥檒l recall that the late, much-regretted boom had completely transformed the Emerald Isle. All of a sudden, the Irish were the richest people in Europe (based on the value of their houses, mostly)鈥nd hundreds of thousands of Poles and other immigrants were streaming into Ireland in order to find work.
Practically all the waitresses and barmaids in Dublin seemed to have an Eastern European accent. And there was even a Polish-language TV station. Can you believe it?
But then came the bust. Suddenly, the Irish had to come back down to the bog. The jobs disappeared. Housing prices fell (though not yet as much as you鈥檇 expect). And the immigrants began to go home.
Along with the immigrants were many native-born Irish too,
Yes, 鈥淭he Irish Exodus鈥� has resumed, reports The Globe and Mail.
鈥淗undreds of thousands of immigrants used to flock to Ireland, looking for work at the door of Europe鈥檚 strongest economy. But after two decades and a stunning collapse, Ireland is once again a nation of emigrants, seeking employment elsewhere to escape the sad reality at home.鈥�
Oh well, it was bad while it lasted. Now, the Irish can give up property development and go back to poetry and alcohol. The country may not be as prosperous, but it will surely be prettier.
Seventy thousand people are expected to leave the island this year. By 2015, the total is expected to rise to 200,000, if unemployment trends continue.
Where are they going? Canada. New Zealand. Australia. No mention was made of the USA.
But what is most interesting to us is the story behind the story. Ireland is not only the European nation the farthest out to the West. It is also the one the farthest out in front in the fight against deficit spending. While others dilly-dallied, Ireland cut. It bailed out its big banks鈥nd then had to protect its own credit. But despite deep cuts, the deficit remains stubbornly high. At 11% it is in line with the US, which hasn鈥檛 made any effort to cut at all.
What went wrong?
It appears that the neo-Keynesians Krugman and Wolf are right about at least one thing. Cutting government spending while the private sector is de-leveraging is a hard way to go. (In our opinion, it is the right way to go鈥ut that鈥檚 another issue!)
What happens is that as the feds cut back it reduces income to the private sector, which is itself in cutback mode. This then causes tax revenues to fall 鈥� which increases the deficit鈥�
You end up with a vicious cycle of cuts, deficits and more cuts鈥hich doesn鈥檛 worry us鈥ut the feds don鈥檛 like it. And the public doesn鈥檛 care for it much either. Better to wait until the private sector has finished de-leveraging, say most experts.
Of course, then you are only building up public sector debt 鈥� which will have to be repaid sometime. You are also wasting resources 鈥� forever 鈥� making people absolutely poorer than they otherwise would be.
But we鈥檙e going to let it slide this morning.
The point we are reaching for is that de-leveraging isn鈥檛 easy. It鈥檚 like growing old. That鈥檚 not easy either. Still, it鈥檚 better than the alternative.
And as for which of the views is correct 鈥� recovery, inflation, hard deflation or soft deflation 鈥� we鈥檒l just have to wait to find out.
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