Bill is away until 17 April. So in his absence, we'll bring you some of his most insightful, caustic and witty observations from the last 14 years. This article was first published on 6 August 2010.
In absentia The Argentinian Outback
On Sunday, we celebrated America's independence from Britain.
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Having just come from London, it's hard to see what the fuss was all about. The English seem like decent people. The Queen still has her dignity. The British government seems no worse than its American counterpart. And David Cameron appears to have a much better idea of what he is doing than the Obama team.
Cameron is calling for austerity'. He wants the British public to make sacrifices so that British public finances can be brought back under control. We have some doubt that he will succeed. As far as we know, no democratically elected government has ever been able to reduce its debt burden during a credit contraction.
A number of governments including the US and Britain managed to reduce their debt in the '80s and '90s. But that was when their economies were booming. As long as the economy is growing faster than the debt, the burden of debt will decline as a percentage of GDP. The '80s and '90s were boom years. Credit was expanding. People were buying more and more things they didn't need with more and more money they didn't have.
Obviously, that kind of boom can't go on forever. And when it came to an end in 2007 it changed the financial picture for governments as well as households and businesses. Tax revenues went down. Expenses went up. And so did the bailouts and boondoggles that they call stimulus' spending.
As deficits rise, so does debt. And so do the voices who tell us that debt is nothing to worry about. Those voices led by Paul Krugman at The New York Times mention the debt decline of the '80s and '90s. They say we can "grow our way" out of debt this time, just like we did the last time.
Here at The Daily Reckoning we don't rule out anything. The day is long past when we said anything with absolute, unshakeable conviction. Today, even when someone asks us our name, we check the initials on our undershirt just to be sure.
Might the US and Britain grow' their way out? Well, anything is possible. But two things make it unlikely. As we said above, we're in a credit contraction. It's part of what we call the Great Correction. Growth rates are going to be low and occasionally negative. US government deficits, on the other hand, are scheduled to be over 5% of GDP from here to kingdom come. And if David Stockman is right, they could stay over 10% of GDP for the foreseeable future. Stockman is the former head of OMB during the Reagan Administration. He predicts deficits as high as $2 trillion per year, thanks to a weak economy and strong spending by the feds.
The second thing that makes it unlikely that we will be able to grow our way out of debt is the composition of the economy. More and more of it is under the control of government. Growth' in this economy is largely phony. It reflects activity. But not prosperity. The activity, therefore, is not the sort that you can tap to pay down your debt. Instead, it adds to the debt.
You can see how this works just by imagining what would happen if the feds hired a million census takers. The economy would appear to grow' maybe even faster than the debt. But the economy itself would be hollow and less able to sustain the debt burden.
The other example used by Krugman et al is WWII. At the end of the war, US debt was equivalent to what it is today, as a percentage of GDP. "Hey, what's the big deal? It didn't do us any harm then," they say.
But the federal government was actually in a much stronger financial position back then. While it had about the same official national debt, it faced almost no off-the-books unfunded liabilities, financial guarantees, and open-ended commitments. The last time we looked, these off-balance sheet debt items such as for health care programmes totalled more than $50 trillion.
And then, there's the private sector debt too. That's about $50 trillion too.
How much net private debt was there in 1950? Almost none.
In the post-war period we were in a different stage of the credit cycle. People were just beginning to spend. They didn't have a mountain of debt. They had a mountain of savings!
Yes, dear reader, people made sacrifices during the war years. They had put off consuming. Then, soldiers came back from Europe and the South Pacific with pent-up demand, and real savings that they could put to work. So, the economy was ready for a credit expansion, not a contraction. People had lived through the lean years. Now they were ready for some fat ones. The economy too was ready to rock and roll. It had been converted to a war footing. Now it was ready to meet consumer demand.
This is the opposite of the picture today. Few sacrifices were made over the last 50 years. Instead, the last five decades were a time of increasing extravagance. That's why sacrifices are necessary today.
Households are only now beginning to cut back. Governments in Europe are cutting back too or so they say. And under the sway of Krugman and other neo-Keynesians, the US government continues to run huge deficits, hoping that the debt will be refinanced and repaid, as it was after WWII.
But probably the nicest thing about after WWII was that there was an after WWII. The war had a beginning and an end. When it was over people were finally able to get on with their lives. The economy was ready to switch to a new phase too from making tanks to making hot water heaters. And, finally, governments could stop borrowing and begin repaying their debt.
The major trouble with today's struggle is that there is no end in sight.
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