[THS] Mike Whitney: We Need Bigger Deficits. Or we're toast

[Peter Webster]

http://www.informationclearinghouse.info/article24919.htm

We Need Bigger Deficits. Or we're toast

By Mike Whitney

March 04, 2010 "Information Clearing House" -- Barack Obama must choose between
high unemployment or large fiscal deficits. It's one or the other. If he chooses to
increase government spending and provide a second round of stimulus;
unemployment will fall, the output gap will narrow, business confidence will
strengthen, and the economy will continue on the path of recovery. If he refuses to
provide more stimulus; unemployment will hover around 10 percent, credit will
continue to contract, confidence will flag, and the economy will underperform for
years to come. And--surprise, surprise--the deficits will balloon anyway, because
household deleveraging is going to continue regardless of what the administration
does. That will slow consumer spending and reduce tax revenues which will only add
to the budget shortfall. So, it's not a matter of whether we will have deficits or not.
We will, no matter what. The question is whether we'll suck-it-up and do what needs
to be done (by investing in our future and putting people back to work) or follow
some monkish austerity program which will only make matters worse.

The media has played a big role in fueling deficit hysteria. It's all part of a well-
funded public relations campaign aimed at putting the government on a starvation
diet. The long-term goal is to privatize public assets, crush the labor movement, and
dismantle the social safety net. A recent article in counterpunch by author Ellen
Brown exposes some of the people behind the "fiscal responsibility" movement and
shows that what they really want is to divert Social Security benefits into a
"mandatory savings tax" that would be automatically withdrawn from workers
paychecks into an "investment pool" that Wall Street bankers would manage. Nice,
eh? The banksters would rather skip the niggling task of fleecing their victims
themselves and, instead, have the remittances posted directly to their accounts. It's
more efficient that way. Here's an excerpt from Brown's article:

"When billionaires pledge a billion dollars to educate people to the evils of something,
it is always good to peer closely at what they are up to. Hedge fund magnate Peter
G. Peterson was formerly Chairman of the Council on Foreign Relations and head of
the New York Federal Reserve. He is now senior chairman of Blackstone Group...
Peterson is also founder of the Peter Peterson Foundation, which has adopted the
cause of imposing “fiscal responsibility” on Congress. He hired David M. Walker,
former head of the Government Accounting Office, to spearhead a massive campaign
to reduce the runaway federal debt, which the Peterson/Walker team blames on
reckless government and consumer spending. The Foundation funded the movie
“I.O.U.S.A.” to amass popular support for their cause, which largely revolves around
dismantling Social Security and Medicare benefits as a way to cut costs and return to
“fiscal responsibility. " (Ellen Brown, "IMF-style Austerity comes to America",
counterpunch)

To summarize, deficit hysteria is a hoax concocted by far-right demagogues who are
trying to advance their socially-destructive agenda for their own personal gain.
Fortunately, the opposition has mounted an impressive counter-attack and refuted
many of the spurious claims made by the deficit worrywarts. New York Times
columnist Paul Krugman has done a particularly good job of educating the public on
the issue and analyzing the movement's supporters. Here's a clip from his article
titled "Fiscal scare Tactics":

"To me ...the sudden outbreak of deficit hysteria brings back memories of the
groupthink that took hold during the run-up to the Iraq war. Now, as then, dubious
allegations, not backed by hard evidence, are being reported as if they have been
established beyond a shadow of a doubt. Now, as then, much of the political and
media establishments have bought into the notion that we must take drastic action
quickly, even though there hasn’t been any new information to justify this sudden
urgency. Now, as then, those who challenge the prevailing narrative, no matter how
strong their case and no matter how solid their background, are being marginalized.

True, there is a longer-term budget problem. ....But there’s no reason to panic about
budget prospects for the next few years, or even for the next decade (because)
interest payments on federal debt; according to the projections, a decade from now
they’ll have risen to 3.5 percent of G.D.P. How scary is that? It’s about the same as
interest costs under the first President Bush.

Thanks to deficit hysteria, Washington now has its priorities all wrong: all the talk is
about how to shave a few billion dollars off government spending, while there’s
hardly any willingness to tackle mass unemployment. Policy is headed in the wrong
direction — and millions of Americans will pay the price." (Paul Krugman, "Fiscal
Scare Tactics" New York Times)

The basic problem is not hard to grasp; the private sector (us) cannot save unless
the public sector (the government) runs a deficit. The surpluses of the Clinton era
were produced by private sectors deficits. In other words, the buildup of household
debt during the late 1990s and early 2000s, (remember all that debt-fueled
consumption?) allowed the federal government to run a surplus. Now that the bubble
has burst, the process has switched into reverse. Consumers are no longer able to
spent at pre-crisis levels because the value of their main assets--their homes and
their retirements funds--has dropped precipitously. Thus, households will have to cut
back on their spending and either pay-down their debts or set more money aside to
repair their balance sheets. The slowdown in spending, along with the reduction in
bank lending and consumer credit, will push the economy back into recession unless
the government steps up its spending and increases the deficits. So far, Obama's
fiscal stimulus has performed as well as can be expected by reducing the output gap
and increasing employment by roughly 2 percent. But the original stimulus ($787
billion) was not nearly large enough to fill the capital-hole created by the financial
meltdown. We need another jolt. Also, the effects of the stimulus will begin to
diminish in the second half of 2010. That's why economists are so concerned,
because without additional stimulus, more slack will build-up in the system and a
large portion of the workforce will remain jobless. .


US households sustained humongous losses during the recession; nearly $12 trillion
has been slashed from home equity and personal savings in the last two years.
Millions of baby boomers, who believed they had sufficient savings for retirement,
now must either put off their retirement and work longer, or cut back sharply on
spending to pad the nest-egg. The process of deleveraging typically lasts for 6 to 7
years following a financial crisis according to McKinsey Global Institute. Unfortunately,
recent data show that US households have barely begun the process. Their debt-to-
disposable income ratio is still extremely high and must return to its historic trend.
That means they will not be able to spend as freely as they did before. As private
spending slows, businesses will be forced to reduce inventory, lay off workers, and
curtail investment. (There's no need to reinvest when the system is already saturated
with overcapacity.) When consumers can't spend, and businesses have no incentive
to invest; the economy nosedives. The government can either boost stimulus to make
up for the loss in activity or cut spending and risk another recession.

Traditionally, liberals have aligned themselves with progressive economic theory
(Keynes) which recommends running large fiscal deficits during downturns. Past
experience indicates this is the most effective approach, although the strategy does
have its critics. Many of those same critics, however, believe that the United States is
at risk of a sovereign default, which is a ridiculous idea that demonstrates a basic lack
of understanding about the monetary system. When a nation pays its debts in its own
currency, like the US, it can inflate its currency, but not default. This is just more
demagoguery from deficit hawks similar to their nonsensical blather about looming
hyperinflation. That won't happen either. In fact, in the short term the biggest
danger is disinflation leading to outright deflation. Now that the Fed is winding down
its lending facilities and ending quantitative easing (QE) and Obama's stimulus is
dissipating; the signs of contraction are becoming more and more apparent.
Consumer credit is shrinking, M3 is dropping, unemployment remains stubbornly
high, and as this graph from Krugman illustrates, core inflation is falling fast. (which,
in effect, raises real interest rates.)
http://krugman.blogs.nytimes.com/2010/03/02/disinflation-in-recessions/

What does it all mean? It means the Fed has backed itself into a corner and may
have to resume its bond-purchasing program to pump more liquidity into the
financial system to avoid a downward spiral. We are not out of the deflationary woods
yet. Not by a long-shot.

So we need more stimulus and we need it now. Unfortunately, the deficit hawks have
persuaded a narrow majority of the people that, what the economy really needs, is a
systemwide debt-purge that will drive down assets prices, increase defaults, and
send blood running out into the streets. "Liquidate everything!" Somehow this
claptrap has even caught fire with people on the left. It makes the prospect of a
double dip recession even more likely.


BE CAREFUL WHAT YOU WISH FOR...

But there are pitfalls to budget surpluses as economist Randall Wray points out in his
article "The Federal Budget is NOT like a Household Budget" on New Deal 2.0:

"The US federal government is 221 years old, if we date its birth to the adoption of
the Constitution....With one brief exception, the federal government has been in debt
every year since 1776. In January 1835, for the first and only time in U.S. history, the
public debt was retired, and a budget surplus was maintained for the next two years
in order to accumulate what Treasury Secretary Levi Woodbury called “a fund to
meet future deficits.” In 1837 the economy collapsed into a deep depression that
drove the budget into deficit, and the federal government has been in debt ever
since. Since 1776 there have been exactly seven periods of substantial budget
surpluses and significant reduction of the debt. From 1817 to 1821 the national debt
fell by 29 percent; from 1823 to 1836 it was eliminated (Jackson’s efforts); from 1852
to 1857 it fell by 59 percent, from 1867 to 1873 by 27 percent, from 1880 to 1893 by
more than 50 percent, and from 1920 to 1930 by about a third. Of course, the last
time we ran a budget surplus was during the Clinton years. I do not know any
household that has been able to run budget deficits for approximately 190 out of the
past 230-odd years, and to accumulate debt virtually nonstop since 1837.

The United States has also experienced six periods of depression. The depressions
began in 1819, 1837, 1857, 1873, 1893, and 1929. (Do you see any pattern? Take a
look at the dates listed above.) With the exception of the Clinton surpluses, EVERY
SIGNIFICANT REDUCTION OF THE OUTSTANDING DEBT HAS BEEN FOLLOWED BY A
DEPRESSION, and every depression has been preceded by significant debt
reduction....our less serious downturns have almost always been preceded by
reductions of federal budget deficits. I don’t know of any case of a national
depression caused by a household budget surplus." (Randall Wray, "The Federal
Budget is NOT like a Household Budget: Here’s Why", New deal 2.0)

Repeat: The seven periods of budget surpluses in the US were followed by six
Depressions. Will this be the seventh? It depends on whether sanity prevails and
Obama pushes another stimulus package through congress. Otherwise, we're toast.