The abyss: teetering or plunging – you decide

” The American economy is on the edge of catastrophe, and much of the Republican Party is trying to push it over that edge.” Paul Krugman.  The rest of his impassioned column below the fold.  Of course Australia’s economy is not in the kind of dire straights the US one is in (at least not now, but we’ve got our foreign debt to think about if we think it’s going to be a walk in the park for us.)  But it still made me think of how much we might pay for business as usual from the Opposition. When was the last time the Liberals in national opposition were responsible?  Well the ALP aren’t paragons in Opposition either of course, but somehow , I can’t see them playing such an obviously spoiling role when the chips are down. No doubt some others will disagree.

On the Edge, by Paul Krugman, Commentary, NY Times: A not-so-funny thing happened on the way to economic recovery. Over the last two weeks, what should have been a deadly serious debate about how to save an economy in desperate straits turned, instead, into hackneyed political theater, with Republicans spouting all the old clichés about wasteful government spending and the wonders of tax cuts.

Its as if the dismal economic failure of the last eight years never happened yet Democrats have, incredibly, been on the defensive. … Somehow, Washington has lost any sense of whats at stake of the reality that we may well be falling into an economic abyss, and that if we do, it will be very hard to get out again.

Its hard to exaggerate how much economic trouble were in. The … implosion of the Bush-era housing bubble has set economic dominoes falling not just in the United States, but around the world. …

Meanwhile, our main line of defense against recessions the Federal Reserves usual ability to support the economy by cutting interest rates has already been overrun. The Fed has cut the rates it controls basically to zero, yet the economy is still in free fall.

Its no wonder, then, that most economic forecasts warn that in the absence of government action were headed for a deep, prolonged slump. … Worst of all is the possibility that the economy will, as it did in the 30s, end up stuck in a prolonged deflationary trap.

Were already closer to outright deflation than at any point since the Great Depression. In particular, the private sector is experiencing widespread wage cuts for the first time since the 1930s, and there will be much more of that if the economy continues to weaken.

As the great American economist Irving Fisher pointed out almost 80 years ago, deflation, once started, tends to feed on itself. As dollar incomes fall…, the burden of debt becomes harder to bear, while the expectation of further price declines discourages investment spending. These effects of deflation depress the economy further, which leads to more deflation, and so on.

And deflationary traps can go on for a long time. Japan experienced a lost decade of deflation and stagnation in the 1990s and the only thing that let Japan escape from its trap was a global boom that boosted the nations exports. Who will rescue America from a similar trap now that the whole world is slumping at the same time?

Would the Obama economic plan, if enacted, ensure that America wont have its own lost decade? Not necessarily: a number of economists, myself included, think the plan falls short and should be substantially bigger. But the Obama plan would certainly improve our odds. And thats why the efforts of Republicans to make the plan smaller and less effective to turn it into little more than another round of Bush-style tax cuts are so destructive.

So what should Mr. Obama do? Count me among those who think that the president made a big mistake in his initial approach, that his attempts to transcend partisanship ended up empowering politicians who take their marching orders from Rush Limbaugh. What matters now, however, is what he does next.

Its time for Mr. Obama to go on the offensive. Above all, he must not shy away from pointing out that those who stand in the way of his plan, in the name of a discredited economic philosophy, are putting the nations future at risk. The American economy is on the edge of catastrophe, and much of the Republican Party is trying to push it over that edge.

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21 Responses to The abyss: teetering or plunging – you decide

  1. Ken Lovell says:

    I’m on Krugman’s side. But I can’t help thinking that conservatives felt exactly the same way about opposition to the ‘War on Terror’ … that this was an unprecedented global crisis, their world was on the edge of the abyss, and lefties were blind to the danger.

    Maybe we’ve entered an era of irrationality and hyperbole where sensible government will be impossible.

  2. melaleuca says:

    “… but weve got our foreign debt to think about if we think its going to be a walk in the park for us.”

    Does private foreign debt really matter? The libertarian types over at Catallaxy have always said economists shouldn’t be concerned about it. I don’t know enough about it to have an informed opinion one way or the other.

  3. This is the ‘consenting adults’ view. It’s a good starting point. But consenting adults have managed to get us into some pretty fixes lately. You’d think you could leave it to consenting adults to decide whether one of them wants to take out a sub-prime loan, buy a CDO or (ehem) put money in a bank.

    Turns out that in some circumstances, when push comes to shove, it’s not so simple. Anyway, New Zealand is – as in so many things in deregulation – a few steps ahead of us. They’ve been running 8.5% CADs for a while now and it’s rising. S&P have just put them on watch for a credit downgrade. There’s good news and bad news about that. The good news is that we have NZ as a leading edge guinea pig for us in testing the limits of the consenting adults view. If they can stay leading edge rather than bleeding edge, so much the better. Of course if it something nasty happens to NZ, there’s the bad news.

    In one word: Contagion.

  4. tim quilty says:

    Or. We could be $200 billion down and still sliding into recession, nothing to show for it. It’s not as if the Australian government isn’t going to pass the stumulus through the senate with Green support, so it’s hard to see exactly why all the protest.

    Still, it makes me feek better that you know definitively what the solutions are for this particular crisis Nick, because I sure as hell don’t. I do know if I get a $950 check from Mr Rudd it’s going straight to the mortgage. Along with everyone else, if todays lunch conversation at work is anything to go by. Which may be defeating the whole stimulus thingy, but what are you going to do?

  5. observa says:

    Testimony by Henry Morgenthau Jr, Roosevelt’s treasury secretary, on May 9, 1939 to the House Ways and Means committee:
    “We have tried spending money. We are spending more than we have ever spent before and it does not work. And I have just one interest, and if I’m wrong … somebody else can have my job. I want to see this country prosperous. I want to see people get a job. I want to see people get enough to eat. We have never made good on our promises … I say after eight years of this administration we have just as much unemployment as when we started … And an enormous debt to boot.”

    Give those 47-64 yr old baby boomers a grand and they’ll do exactly what tim and his mates would do with it. Pay off debt or sock it away in the bank. Govts can’t fight demographics in developed economies now. Fascinating to watch them all in exercises in futility now. We’re no smarter or wiser than our grandparents in the 1930s really.

    Last year SA Treasurer Kevin Foley was looking forward to a $100 mill deficit for this fin yr, with the State Bank debacle being finally paid off within a year or two (that was around a $3bill bailout loss as I recall) Now in a matter of months he’s looking at a $1.5 bill black hole in the budget after years of SA sacrifice. Bear in mind that much of that State Bank debt was to bailout lenders, mainly large debenture holders, to its bankrupt Finance Co subsidiary.

  6. observa says:

    It collapsed in 1992 by the way and we’re still paying off the debt even after privatising ETSA to help pay down the debt, albeit there was Keating’s competition reform agenda to consider too. You can imagine his dismay at that $1.5 bill now which puts Rudd’s $42bill into some national perspective.

  7. Fred Argy says:

    The RBA, relying on past evidence, tells us that monetary policy takes at least a year to make its full impact.

    Add in the effects of the new stimulus package (plus perhaps a bit more on unemployment benefits) and the writing back of our currency rates – and we may have the start of a recovery by late 2009.

    That is the way the RBA is playing it. And for the present time, this is the way the Rudd Government is playing it. Let us be satisfied with small benefits.It would be unreasonable of us to expect more, given Turnbull’s strong anti-deficit stance.

  8. Yes Observa,

    The FDR Administration really tried spending money – especially in 1937 when they contracted the budget and managed to bring on another economic contraction. Why did the huge deficits associated with WWII manage to turn the situation around so comprehensively?

  9. AdrienSword says:

    Count me among those who think that the president made a big mistake in his initial approach, that his attempts to transcend partisanship ended up empowering politicians who take their marching orders from Rush Limbaugh.

    I disagree.

    First because that’s one of the things he’s always said he stood for and he was duty bound to try it. Second because if what he does turns out to work than it will discredit those who stood against him.

    BTW – Considering the possibility of the return of protectionism: I wonder, if our situation turns out to be nowhere near as dire as the US, and if we then get flooded by Americans seeking to use the free trade agreement – what?

  10. observa says:

    ‘Why did the huge deficits associated with WWII manage to turn the situation around so comprehensively?’
    Because they came with some rather extreme economic control measures that I haven’t heard being proposed just yet? What are you suggesting? Rationing and Manpower controls? A rather interesting approach to an oversupply of labour too I would have thought.
    The consensus seems to be we’ve learned from any mistakes of the New Deal and will not make the mistakes of its shortcomings this time round. I think that’s monumental conceit, since everyone seems to be ignoring the obvious, that this is largely demographic. Policymakers certainly anticipated some problems with the aging of the BBers, it’s just that they haven’t had the moment of clarity to recognise it’s on them now with a bloody great bang rather than a whimper. Their Great Moderation phase is over (after their Great Stagflation phase)and the Great Geraiatrification has begun.

    I note the first two phases completely flummoxed all the experts at the time too, but it’s about time we all stopped being slow learners and saw the obvious when its belting us all around the head. We are not going to inflate our way out of this nor get a significant 47-64yr old demographic cohort to take on more leverage and debt at their stage of life. I’m not against Keynesian fiscal measures to smooth some temporary business cycle, but I am against them being used to defy demographic decline and attempts to pass the buck to another innocent generation. That’s where we’re going with monetary measures to prop up BBer asset prices and those fiscal handouts with consequent debt. What my generation failed to save in real terms for their retirement should not be gouged surreptitiously from their offspring, now and well into the future. Keynesians have to take a good hard look at themselves in the mirror now and ask themselves, just whose interests are they serving.

  11. observa says:

    If you still can’t see it Nicholas, ask yourself what age all these economic advisors, policymakers and politicians are at present and just what they’re advocating? Who’s greater interest is it to guarantee all bank deposits? The young or the old? Who’s interest is it to guarantee asset prices and those concomitant Super balances? ie who holds the greatest Super balances? Then ask yourself what age you are and what vested interests do you have in unsweving faith in Keynesian monetary and fiscal policy?

  12. Do I believe what I do because I’m really just trying to get my share portfolio back up where I had hoped it belonged? It’s a fair cop.

    I can’t believe you’re as clever as you are Observa. You’ve tricked me into giving myself away – right here in public. And with any luck I’m going to be overtaken by an overwhelming urge to press the ‘submit’ button and then it will be too late. You will have outsmarted me.

    In fact I think I can feel the urge to press ‘submit’ overtaking me right now . . .

  13. observa says:

    On second thoughts perhaps the useless bastards deserve it,27574,25024784-1702,00.html

  14. NPOV says:

    observa, re your “attempts to pass the buck to another innocent generation”, I assume you’re talking about the need to raise ~$50B to ultimately pay for the current stimulus packages? But if that was to be paid off over 10 years and paid for entirely with extra taxes, then assuming a population of 10 million taxpayers, that’s only $500/yr or so per taxpayer (ignoring interest) – which once combined with the economical growth that will occur over that period will still mean that generation will enjoy higher standards of living than we currently do, so it’s not really all that much of a buck to pass, is it? Especially if not attempting a $50B stimulus package would cause the recession to last 2 years longer, in which case the average citizen would most likely be more than $500/yr worse off – though perhaps not the average *employed* citizen.

  15. melaleuca says:

    And thanks to the GFC and the consequent lower interest rates, most of us with mortgages are now saving at least an extra $2,000- $3,000 a year. On top of that inflation is plummeting.

    The “debt burden” thingie doesn’t look so bad when you put in context.

  16. observa says:

    Only $500/yr to pay back eh? And here was I recalling small business overdraft rates once hitting 23%, but never mind Glenn Stevens has got that and the banks all in comfortably in hand. Trouble is at those rates while the indebted are enjoying a nice holiday, I noticed a lot of businessmen bemoaaning on the ABC tonight how they couldn’t borrow from the banks to stay afloat. Guess who will go down with their boats? Not to mention that it’s real savings and investment that raises all boats in the long run. Ah well if there’s no savings for business and private investment dries up there’s always Govt to the rescue with bailouts for childcare empires, car manufacturers, car dealers, commercial construction, insulation suppliers,……fill in anything else that comes to mind or looks like sinking.

  17. observa says:

    I’ll go one better than the ‘world’s greatest treasurer’ here and predict that not one incumbent State Govt will produce a surplus before losing office, on top of that certainty about the Rudd Govt. Maintain that faith lads. How did it go again in less than a year?
    gotta raise interest rates to fight inflation – oops looks like we’ll have to stop because of the sub-prime- no worries it won’t affect us- our banks are safe- besides we’ve got China and we’re decoupled- oops better start lowering interest rates- better lower them in bigger jumps because we’re only going to grow 2% next year- better introduce some legislation to guarantee deposits up to $20k- oops no time better guarantee all deposits- might be looking at a downturn- make that a GFC- looks like worst in 30 years- make that worst recession since WW2- make that worst recession since the 1930s- we have to have a stimulus package to avoid a depression again like the 30s- run around in ever diminishing circles.
    Help! Just do something! Anything! Help! Anybodeeeeeee..! Groundhog 1930s

  18. observa says:

    So let’s summarise. GennY are up to their tits in debt now so let’s hock everyone up for $500 a year for 10 yrs (without interest) to avoid nasty things that go bump in the night right now. The oldest BBer is now 64 and the youngest 47 so they’ll be dropping off paying the tab in big numbers and at the same time consuming more medical, hospital, aged care, not to mention that call on pensions at the same time any self funded retirees are earning next to zero on their savings.

    In 1992 when the SA Govt bailed out the State Bank with losses of $3.3 bill ‘we’ (1.6 mill of us today) began paying it off. We even flogged ETSA and kicked that in and just as we were looking like paying off that debt in the next year or so ($100mill budget deficit accounting for repayments), suddenly Treasurer Foley finds he’s got a $1.5bill black hole staring him in the face again. The answer? Swan will hock his current taxpayers up to the tune of another $500/yr (without interest) for the next 10 yrs to help out. SA has one of the oldest populations in the country by the way so I may be going a bit dotty, but something does not compute here children.

  19. Tel_ says:

    On second thoughts perhaps the useless bastards deserve it

    I believe that Gen-Y were just quicker than most to recognise that you can get anything you want so long as you just keep borrowing and insist that the government protects everyone from any consequences. Since the BBers had been busy doing exactly that, Gen-Y could see a nice safe political stalwart against any debt crackdown.

    When the BBers are too old to be able to work, and they demand that Gen-Y pay back the debt, Gen-Y will simply hit them with a wave of inflation that obliterates the debt and everyone’s savings in one fell swoop. If the BBers use their political power to crank tax and make life difficult enough for Gen-Y then the best and brightest Australians will go overseas (indeed a great part of Gen-Y have already done that) then earn high wages in Germany, Japan, China, etc while the Aussie dollar continues to devalue. When they come back to Aus, loaded up with Euros they can buy back whatever they want.

    From an economic point of view, those that have the thing in short supply and high demand are always the winners. Gen-Y don’t have to be overly cautious in this game because they can already see how it ends.

    To some extent, the BBers have been content to try to fill that demographic gap with high immigration (while Howard was whacking the boat people for front page news, he was still encouraging high total immigration numbers, Rudd is continuing the same). Of course, the new Australians don’t feel any particular urge to support the BBers either, and the faster we bring in immigrants, the faster the politicians learn to pander to this new voting majority.

    Seems to me that Gen-Y are doing exactly what a self-interested rational party would do under the circumstances.

  20. observa says:

    Well you’re probably right there Tel and so long as they’re out from underfoot soon, then what the hell! The only fly in the ointment I can see for GenY is kickstarting that inflation to get the ball rolling. If they can manage that then there might be a wee counterproductive sting in the tail with interest rates round the corner. I’m with Steve Keen that not much will happen without asset prices adjusting downwards.

  21. Tel_ says:

    Im with Steve Keen that not much will happen without asset prices adjusting downwards.

    The real value of assets will certainly fall, but there’s no particular reason to believe that the dollar value of assets will fall. There’s huge political pressure to keep asset prices stable (in dollar value) and a mix of government spending and falling interest rates should do the job of kickstarting inflation. Nothing has actually been done to solve the skills shortage either so skilled workers are going to continue to demand higher wages (and rightly so).

    The thing about Steve Keen’s “debt deflation” theory is that almost no one actually believes it, and anyone influential who does believe it has a great vested interest in seeing to it that it never happens.

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