Tuesday, January 06, 2009

Spend Spend Spend

The original New Deal only cost $500bn (in today's money)

Here in the UK we're at last getting some fiscal blue water between Labour and Tories. Gordo wants to spend us out of recession, whereas Dave wants us to save. As Dave told us yesterday:

"We need to make a really big change: from an economy built on debt to an economy built on savings, from a country and government that has lived beyond its means to one that lives within its means."

We need to change from a spend, spend, spend society into a save, save, save society.

The FT doesn't like it. In a leader penned by Saints Keynes and Augustine it says:


"The [Cameron] schemes misread the real present danger for the UK; the paradox of thrift. If this plan worked, and more Britons started to save more for a rainy day, spending might collapse – and the recession would deepen. In the medium term, the UK needs to increase its savings rates: net household saving has been negative for some years. But, please, not now. This is surely the right time to encourage people to spend, spend, spend."

So who's right?

Elsewhere on the FT's own website, our old friend the Prof (Buiter) points us towards the answer by taking a good hard look at the massive Bush/Obama fiscal package being cobbled together in Washington. The Prof asks "Can the US economy afford a Keynesian stimulus?" His worrisome answer is no - or at least, not on anything like the massive scale envisaged.

He identifies what he labels the Keynesian fallacy - “The long run is just a sequence of short runs, so if we make sure things always make sense in the short run, the long run will take care of itself.” And he highlights some fundamental problems with this approach (my rough summary with a few additions):
  • Short-term policies can have highly damaging long-term effects, which are more than just the simple sum of short-run effects (and unfortunately the "long-term" may turn out to be only a few years - not nearly long enough for us all to be safely dead with our grandchildren left to clear up the mess)
  • We don't understand nearly enough about how the economy works to predict how big policy changes will work through; we could easily trigger all kinds of unwanted and unanticipated side effects; we could easily destabilise things even more (as we discovered back in the 60s and 70s)
  • Most people are forward looking - the government cannot simply assume its debt financed splurges will leave our behaviour unchanged (eg as we've blogged before, the prospect of future tax rises might lead us to save more now)

There's also The Big Problem we've blogged many times - what happens if/when international investors lose confidence in a highly indebted government?

Clearly, they have not yet done so in the case of the US, but as the Prof points out, the Bush/Obama package is shaping up to be huge (a minimum of 5% of GDP over two years*), with correspondingly huge borrowing. Yet money poured into failing auto makers and the like most assuredly will not boost US productivity. It will do nothing to address the fundamental problems of an economy that for too long has lived well beyond its means (ie its savings rate is zilch and it runs a chronic current account deficit).

And one day there will be a horrible reckoning:

"I don’t believe the US has either the external credibility or the goodwill capital any longer to ask, Oliver Twist-like, for a little more leeway, a little more latitude. I believe that markets - both the private players and the large public players managing the foreign exchange reserves of the PRC, Hong Kong, Taiwan, Singapore, the Gulf states, Japan and other nations - will make this clear.

There will, before long (my best guess is between two and five years from now) be a global dumping of US dollar assets, including US government assets."

And then?

Come on, you know this. We've been here before.

The US defaults on its debt - not overtly, of course, but via a good old dose of dollar depreciation and inflation. Which is pretty well how it paid for Vietnam and the spending excesses of the Great Society back in the 70s. And as you will recall, when they sneezed that lot out, the rest of us contracted more than a slight sniffle. Only this time, it will be a whole lot worse.

So where does that leave us, here on the sceptred isle?

Well, let me see... we currently have a bigger fiscal deficit than the US, we have also saved little, and we are also running a chronic current account deficit. Plus, we have even higher levels of personal indebtedness, and the government has effectively nationalised the combined debts of the entire banking system. The only difference is that unlike the dollar, sterling is not a reserve currency, so the international appetite for sterling debt is hugely lower.

Hmm... doesn't sound altogether reassuring.

The nasty truth is that we are even less able to afford a policy of spend spend spend than the Americans. We need to batten down the hatches and put our trust in God, the Japs, and the Germans to keep international demand going. The more we try to pump up our own spending, the more likely it is we undermine confidence among those kind foreigners who are lending us the money to keep eating.

And once the smoke clears - as it is starting to - those foreign creditors are increasingly going to ask how we intend to dig ourselves out of the debt hole bequeathed by Labour. They'll want to see a credible plan for how we will earn our way back to solvency. They'll want to see sacrifice and enterprise. They'll want to see saving and investment, not spending and borrowing.

*Footnote: That US fiscal splurge is shaping up to be a real Monster. The Wall St Journal gives us the gee-whiz figures that ought to scare the pants off dollar bond investors (quoted at length because Tyler finds these historic comparisons fascinating, and will be referring back to this):

"Barack Obama will soon request an economic stimulus package of some $775 billion over a mere two years and optimistically hopes to hold the final figure under $1 trillion.

$1 trillion is about one-third of annual U.S. government spending and 13% of the U.S. economy. It is more than the GDP of all but 12 countries in 2007 (America, Japan, Germany, China, the U.K., France, Italy, Spain, Canada, Brazil, Russia and India, in that order).

In inflation-adjusted dollars, the Apollo space program cost $140 billion between 1961 and 1972, while the race for the atomic bomb came in at a bargain $29 billion... Thomas Jefferson purchased Louisiana for $15 million in 1803. In today's dollars, that'd be about $261 million; rescaled as a share of the current economy, it'd still be a steal at $409 billion. If the Marshall Plan had started in 2004 instead of 1947, four years of equivalent foreign aid would run us about $755 billion as a share of today's GDP. The Panama Canal opened in 1914 after the U.S. had spent $7 billion in current dollars.

As for the precedents that Mr. Obama is presumably looking to, economists estimate overall outlays for the New Deal at about $32 billion, or $500 billion today. Dwight Eisenhower's interstate highway system, which still remains the largest public works project in the U.S., was originally estimated to take 12 years and cost $25 billion. It actually took 35 years and cost $114 billion, which is more than $800 billion in 2008 dollars.

The only specific American endeavor, ever, that tipped the trillion-dollar scale was World War II. That war -- in which 16 million U.S. troops fought for four years over two fronts -- cost about $4 trillion in adjusted dollars, or $17 trillion in today's GDP. Leave it to Mr. Obama and Congress to make even WWII seem like a relative bargain."

PS If you watched last night's Newsnight you will have seen another extraordinary look-at-me performance by the tax-funded Paxo. Manifestly intent on making George look stupid, he finished his interview by literally accusing G of following round after Dave scooping up D's poop. Which is all perfectly fine, except I don't want to pay for it. As we've said before, come the day, there have to be consequences.

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