Wednesday, 14 March 2012

Three years on, how does the government’s economic rescue look?

SHOULD A GOVERNMENT SPEND more or less in a downturn? Should it inflict “austerity,” or should it spend and borrow and hope?

The issue has once again become a live one as this economy, and all the others, still struggle to resurrect themselves—while all around us commentators and alleged economists lie about the austerity, and deceive about the results of “borrow and hope.”

How refreshing then to see one local commentator who seems to understand money printing is not the answer.

[Bryan Gould & Bernard Hickey have] been complaining that austerity does not work and is no solution to our current woes, he points to Greece, Spain et al, to illustrate his point.
    Greece, however, is a mess precisely because they have never practiced austerity. Greek governments used to print drachmas, and lately borrowed Euros. If borrowing money was a path to riches then Greece would be a wealthy country. It isn’t.

And nor are we.

imageI said four years ago when this calamity first hit that we had no choice about the pain of recovery, only about the length of time it would take. Either a short, sharp shock, or (like Japan) years of grinding lethargy while the supposed plan of “hope and borrow” becomes inexorably the millstone of “hope and pray.”

It’s a shame we weren’t having this discussion back in 2008 when the excrement first hit the ventilation device.

Except we were

Unfortunately, the “great and the good” weren’t listening. Three years ago in February, the “great and the good” instead gathered together in Manukau with John Key and Bill English for the new government’s “Jobs Summit.”  (Remember the “Jobs Summit”?)

imageThe job of the Jobs Summit was to get buy-in from commentators and industry groups for the government’s plan to “rescue” the economy. The “plan” turned out to be borrow to pay for current spending, and borrow even more to pay for new spending. Naturally the plan received buy-in from all those present, since the vast majority confidently expected that new spending to head their way.

It brought to mind Adam Smith’s famous observation:

"People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices." 

This approach however wasn’t just designed to buy votes and keep Fletcher Building et al afloat. It was supposed to keep economy-wide spending up during the downturn, which would (supposedly) help keep up wages and prices, and pay for jobs for everyone who wanted one. 

But it didn’t work.

And we continue to borrow hundreds of millions of dollars a week with no sign at all (except in Treasury’s fantasies) of this borrowing abating.

Fact is, the approach was utterly wrong-headed. If a household borrowed to pay its bills when a home-maker lost her job, we’d call her irresponsible. It she kept borrowing for four years while her situation deteriorated, we’d call her insane.

So why is it that when finance ministers do this they’re considered to be saviours?

imageWORLDWIDE, THE CRASH DESTROYED trillions and trillions and trillions of dollars of wealth. And because of the way money is created in our fiat money system (being essentially debt organised into currency), this meant that trillions and trillions of dollars was destroyed. Money had just disappeared.

By thinking only about aggregate spending however, rather than on where the spending was going, the delusion  is created that this new spending can replace the old spending. But the old spending stopped because businesses had gone to the wall. Because malinvestments had spread throughout the system. Because business after business was struggling to pay its bills, desperate to pay back its own debt, and was beginning (properly) to deleverage itself.

Governments could either help or hinder that process.  They could help by allowing the correction to occur, as happened in the 1920/21 Depression, from which recovery was achieved in about eight months. Or they could try to keep prices up, wages up and spending up (as Herbert Hoover and Franklin Roosevelt did in the thirties, and Japan did again in the nineties) and ensure the pain hung around for years.

Tragically, they chose the latter. They tried to reflate the economy by borrowing; but reflating after a crash and expecting recovery to occur is like reversing over a traffic casualty and expecting him to rise from the dead.

And I said so at the time.  In fact why don’t I just reprint what I said then, and you can see who’s right and who’s wrong (and compare my solutions below to the seven time-honoured methods by which to extend a recession: head to this post and then check out the seven points just above the cartoon):

Friday, February 27, 2009
Jobs Summit, 2: The solutions

Keynesians embraced the notion that the economy could settle into an equilibrium characterized by persisting unemployment. Critics such as Haberler, Pigou, and eventually Patinkin argued [however]that falling wages and prices would increase the real value of money holdings and that the spending out of those real cash balances would restore the economy to full employment…
Roger Garrison, Time and Money (p. 20)

Gathered there now in Manukau is a collection of folks who have all fallen prey to the ‘Grocer Fallacy.’ They all figure that if the government can only keep their own wages and prices up, and spend enough to keep customers coming through their own particular door, then all will be well with their little part of the world.

Poor fools. As anyone familiar with the Fallacy of Composition would understand, what is true for a part is not necessarily true for the whole. This is certainly true about the myopia of the merchants who are currently huddled desperately around the government’s feet.

As I said in Part One of my piece on this Jobs Summit, which addressed some of the problems in most of the mainstream solutions, the primary problem is not to encourage spending but to afford it. We are not in this position because we didn’t spend enough – Gawd help us – but because the world’s orgy consumption over the past few years consumed our pool of real savings – about US$39 trillion of real savings according to Mr Bollard. The primary problem we must now confront is not a drop in spending, but a drop in the resources we now have command over.

imageIn that analysis is contained the necessary solutions to recovery: to refill the pool of real savings, and to correct prices and production as soon as possible to the new realities we now face.

We can rebuild the pool of real savings just as long as we ignore the hysterical exhortations to keep spending.

We can still produce all we need just as long as we allow costs to reflect the new realities.

We can still employ as many people as are willing to work, as long as they are willing to work for what their job is now worth.

Economy-wide, and across the board, we need to stop spending so extravagantly. Urgently. And we need – all of us – to recognise the new worldwide realities we all now face.

Which is to say,

  • Recovery requires lower wages and salaries across the board. Government (both central and local) can certainly start this process, not by congratulating themselves when they refuse to take a pay rise, or when they "cap" their own wages and salaries to the rate of inflation, but by actively cutting the wages and salaries of all those employed by government, right across the board.
    Since the cost of government is such a large part of costs to business, in spending terms alone this will have a huge impact -- not to mention the tremendous example it gives to others.
    Ten percent is a nice round number, and as it happens that was the figure adopted in the thirties when the Forbes/Coates Government cut government salaries, helping to kick off the revival that began less than two years later (and back then government was only a fraction of the size and influence it is today).
    • Policy Solution: Cut government wages and salaries by ten percent.
  • Recovery requires the freedom of wage rates to fall so that (as George Reisman points out) the presently reduced supply of capital and the credit becomes capable of supporting a larger volume of employment and production. The introduction of the minimum wage increased unemployment in the thirties beyond measure; it visibly discriminates against Maori and youth employment. Let us keep people employed in the work they want at a price that is affordable.
  • Recovery requires that producers and investors -– those who control the pool of real savings – have certainty. Sure, governments always like to look as if they’re doing something, but the more they do – and the more they look like they might do – the less certainty producers and investors have, and the more likely they are to keep their money in their pockets. It was this very "regime uncertainty" that was one of the key reasons the Great Depression continued so damned long in the US. Let’s learn from that mistake. Don’t confuse government action, which consumes real capital, with private action – which builds it up.
    • Policy Solution: Reduce regime uncertainty by government doing as little as possible, by getting the hell out of the way, and by stating clearly in advance what little is going to be done so that everyone knows what’s happening – that is, a policy of No Surprises which is far better than a “rolling maul” of meddling before which no one is able to plan ahead.
  • Recovery requires the rapid liquidation of unsound investments. Capital has already been consumed and is now in short supply. Creditors themselves can be endangered because they’re unable to collect what they are owed. The quicker liquidations are allowed to happen, the more rapidly the resources tied up in those investments can be released, and made available for recovery. Which means not listening to most of the whiners at the Jobs Summit who want their own bad positions propped up, but allowing all the malinvestments to be liquidated – to stop consuming capital – to allow mortgagee sales to happen – to insist that debts are paid. (Except of course the “debts” that are owed to the IRD. Those bastards can wait.)
    • Policy Solution: Allow the remaining capital of lenders to be freed up as soon as physically possible by allowing the rapid liquidation of unsound investments.
  • Recovery requires that government stops spending so goddamn much. The single biggest cost to producers is the dead weight of government. Government spending is not investment – it is consumption. We’ve consumed enough – what producers have needs to be made available for recovery. Cutting their wages and salaries would be a good start (see above). Cutting useless and intrusive government departments would be even better; it’s not like there’s a shortage of the bastards to choose from.
  • Recovery requires that the pool of real savings are built up again. According to Mr Bollard, up to $39 trillion has been consumed so far in the current economic collapse. Those savings need to be built back up again – and with real savings, not with the counterfeit capital that caused so much of that capital destruction. (And we must realise that it is not consumption spending that drives an economy, it is spending on production – and we must understand that it is the pool of real savings that drives production spending). In order to achieve this goal, as Mark Skousen explains, the government needs to find ways to stimulate savings and genuine capital reformation – and the best method is simply to remove barriers to capital accumulation, and to encourage everyone, including wage and salary earners, to save. Which means reducing their costs.
    • Policy Solution: Reduce or eliminate taxes on interest and dividends, and resist calls for a capital gains tax.
    • Policy solutions: Resist the temptation to lower interest rates to negative real rates, and let the market leave them where they need to be to encourage the rebuilding of real capital.
  • Recovery requires that the costs of regulation and compliance are urgently reduced. We’ve been hearing the rhetoric for years, that governments are going to reduce compliance costs, and still there’s no serious intent on the horizon – nothing soon enough, anyway. So let’s offer two simple methods by which that can happen NOW.
    The first is to declare several free enterprise zones around the country, at least one in every major population area, in which all taxes and regulations for new development and new businesses are severely, if not savagely, reduced. Which is to say, instead of throwing money we haven’t got at projects that don’t make sense, allow small, new enterprises to attract real investment and create real jobs without the heavy hand of government slowing that process down.
    The second is to introduce a network of Small Consents Tribunals for Resource Consent Applications for projects under, say, $300,000. This, at a stroke, will get builders back to work, and the cost of home-owning come down. You can read the details of how these would work here. Do it now.
    • Policy Solution: Declare several free enterprise zones around the country, at least one in every major population area.
    • Policy Solution: Introduce a network of Small Consents Tribunals for Resource Consent Applications for projects under, say, $300,000.
  • Recovery requires tax cuts. During America’s Great Depression, Franklin Roosevelt raised taxes to usurious heights – as Stephen Moore from the WSJ points out, “the top tax rate under Roosevelt soared to almost 80 percent and then 90 percent, thus smothering any possibility of a [US-led] recovery.” Let us not make that same mistake here. Let us also realise that the single biggest cost to producers is their tax bill. At a time of economic distress, that is a bill few businesses can afford. Taxes must be reduced.
    They must be reduced for producers. And they must be reduced for the person working two jobs to keep their family afloat, and who’s being punished for it.
    A responsible government however would know that they can’t cut taxes without cutting spending. Reality cannot be faked in that way. Roosevelt, for one, tried deficit spending on top of his enormous taxes, with the result that at the end of a decade of deficits fully 17.2 percent of Americans were still unemployed (which was up from 16.3 percent or 8,020,000 in 1931) and those who were still working were trying to pay off a debt that amounted to US$280 billion in 1930s dollars!
    Deficits don’t work. They still have to be paid for. Leaving the bill for future generations is a form of ‘fiscal child abuse.’
    • Policy Solution: Cut taxes. But make commensurate spending cuts first.
    • Policy Solution: Remove the imposition of added taxes on secondary jobs.
  • Recovery requires that the purchasing power of money be at least maintained, and at best enhanced. What this means is that the dollar in our pocket needs to be able to purchase more real goods and services, not less, with every month and year that passes.
    And what this means is that producers must be able to produce more with less, so that real prices can come down – and we can buy more with less. It means that the Reserve Bank must resist the temptation to flood the country with counterfeit capital as they have been, every new dollar of which reduces the purchasing power of every dollar in your pocket. It means they must lower the fractional reserve rate that has allow private banks to so profligately inflate the currency with a reserve backing only a fraction of what a responsible lender would contemplate.
    In short it means they must pull their heads in, insist on deleveraging, and get the hell out of the way so that real saving and genuine capital accumulation can happen.
    • Policy Solution: Restrict the Reserve Bank’s ability to inflate the currency, and remove the ability of private banks to inflate their own credit lines.

In short, to borrow once again the words of CNBC’s courageous Rick Santelli, we need to reward people that could carry the water instead of drink the water.

If that doesn’t happen, then we’ll be needing our own tea party right here in NZ

* * * *

imageI need to make something explicit in my solutions above that at present is only implicit. I say that w e can still employ as many people as are willing to work, just as long as they are willing to work for what their job is now worth. And I say that one solution to looming unemployment is to devise various means by which costs, including wages and salaries, can fall in order to reflect the new economic realities of lower costs.

But while this means lower wages and salaries in monetary terms, in fact in real terms this need not mean a fall at all – and could in act mean a rise in real wages.

This seemingly paradoxical conclusion is reached by means of two related arguments. The first is that if all costs fall across the board, then it follows that the same amount of money will now command a greater number of goods and services – in other words, since the purchasing power of every dollar has been increased, we can now buy more real goods and service with our reduced monetary incomes. In other words, even with reduced monetary incomes, our real incomes may have risen.

The second is that if we resort to cutting hours – or to the nonsensical idea of a nine-day fortnight – and if we maintain full employment, then by that means we are actually producing less, we are reducing our productivity, and so rather than putting us back on the path to prosperity we are instead only marking time at best, or even going backwards. By contrast, if we can maintain full employment, even with reduced wages and salaries, then the economy will not need to fund the extra expenditure required to pay the doles, but it also means that productivity itself can be maintained. Which means we will be producing more with less cost – which is the necessary path to recovery.

This is not sleight of hand. This is just simple economic reality.

After four years of trying, I continue to commend it to your attention.


  1. Jobs Summit, Knowledge Economy Conference, Smart Growth Strategy - all we need is another group of so-called experts trying their hand at central planning. It will work as well for New Zealand as it did for the Soviets.

    I ran into an old friend of mine at a concert last night who said that she had been appointed to the Productivity Commission.

    "What the hell is that?" I asked.

    "Twenty economists in a room," she replied with a chuckle.

    "Locking twenty economists in a room sounds like a positive step," I replied.

  2. Good news from the UK.

    Osborne's austerity drive cut 270,000 public sector jobs last year

  3. That link has some funny shit in it Markus. In particular I had a laugh at this:

    "Dave Prentis, general secretary of the public sector union Unison, said: " public sector job has been lost every 2 minutes and 18 seconds. That's 625 public sector workers joining the dole queues every single day..."

    He clearly admits that pubic sector workers are not capable to find productive jobs elsewhere.

    God, those captchas piss me off. Why do I need that when I sign in via my Google Account? They are impossible to read, I tried audio which simply won't work. I press on today because I want this heard but I already comment a whole lot less because of this stupid thing.

  4. the drunken watchman15 Mar 2012, 10:08:00

    So, is a melt-down inevitable?, or might NZ Inc struggle on like this forever, never doing as well as it could have, but never totally collapsing either?

    Intuitively I feel PC must be right... but don't we sooner or later need ground truth?

  5. Economically inept, or morally corrupt?

    Which one is it?

  6. Prof. Nassim Taleb the author of Black Swan has come out to support Ron Paul. He thinks that Ron Paul is the only candidate that understands the gravity of the economic problems of the country.

    Nassim Taleb Brings Common Sense to CNBC as he supportsRon Paul

  7. If borrowing at a good rate for investing ever makes sense and one considers national infrastructure an investment then right now is a good time for government spending on infrastructure because the cost of borrowing is low.

    It doesn't really matter what the cause of the crunch in economic activity is when considering the opportunity to build roads, bridges or better sewerage systems - if it's affordable (and if not only lenders are charging low rates but workers and their employers are under pressure to find work and therefore provide competitive good value it's affordable) then questions of whether or not austerity in luxuries or a deliberate policy of public spending replacing private makes sense are beside the point of getting value for money when it's available.


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