[THS] Mike Whitney: The Case for a Second Round of Stimulus

[The Harder Stuff in news and commentary]

http://www.informationclearinghouse.info/article25809.htm

The Case for a Second Round of Stimulus

By Mike Whitney

 June 24, 2010 "Information Clearing House" -- Alan Greenspan has joined the ranks
of the deficit hawks and is calling for austerity measures to reduce government
spending. In an op-ed in last Thursday's Wall Street Journal titled "U.S. Debt and the
Greece Analogy", Maestro Greenspan made the case for fiscal belt-tightening and
disputed leading economists, like Nobel prize winners Paul Krugman and Joseph
Stiglitz, who believe that the Obama administration should provide a second round of
stimulus. In the opening paragraph, Greenspan dismisses the idea that cuts in
government spending will push the economy back into recession. Here's an excerpt:

"I believe the fears of budget contraction inducing a renewed decline of economic
activity are misplaced. The current spending momentum is so pressing that it is
highly unlikely that any politically feasible fiscal constraint will unleash new
deflationary forces."

The op-ed features the same circular logic which became Greenspan's trademark
during his tenure at the Fed. The real point of the article does not become clear until
the very end when the ex-Fed chief levels an attack on Social Security. Here's a clip:

  "The federal government is currently saddled with commitments for the next three
decades that it will be unable to meet in real terms. This is not new. For at least a
quarter century analysts have been aware of the pending surge in baby boomer
retirees.

We cannot grow out of these fiscal pressures. The modest-sized post-baby-boom
labor force, if history is any guide, will not be able to consistently increase output per
hour by more than 3% annually. The product of a slowly growing labor force and
limited productivity growth will not provide the real resources necessary to meet
existing commitments. (We must avoid persistent borrowing from abroad. We cannot
count on foreigners to finance our current account deficit indefinitely.)

Only politically toxic cuts or rationing of medical care, a marked rise in the eligible age
for health and retirement benefits, or significant inflation, can close the deficit. I rule
out large tax increases that would sap economic growth (and the tax base) and
accordingly achieve little added revenues." ("U.S. Debt and the Greece Analogy",
Alan Greenspan, Wall Street Journal)

 Greenspan has been riding the "private accounts" bandwagon for more than a
decade. Not satisfied with having reworked Social Security (under Reagan) to serve
as a de facto flat tax levied on the working poor; Maestro now wants to divert the
Mississippi River of revenue-streams into Wall Street's coffers. "The major attraction
of personal accounts is that they can be constructed to be truly segregated from the
unified budget, and therefore are more likely to induce the federal government to
take those actions that would reduce public dis-saving," Greenspan opined in
testimony before Congress in 2005.

Greenspan has allied himself with a small army of like-minded elites who continue to
boost austerity as a path to growth and prosperity. Deficit hawkery has replaced
supply-side theory as the latest viral-form of voodoo economics. It turns established
economic principle on its head to achieve a given political objective.  This is from
Bloomberg:

"Governments have proven they can spur expansion by focusing their belt-tightening
on spending cuts rather than tax increases, according to studies by Harvard
University professor Alberto Alesina and Goldman Sachs Group Inc. economists Kevin
Daly and Ben Broadbent.

“There have been mountains of evidence in which cutting government spending has
been associated with increases in growth, but people still don’t quite get it,” Alesina
said in an interview. He made a presentation to European finance chiefs on the topic
during their April meeting in Madrid.

The key is an emphasis on cutting spending rather than raising taxes, said Goldman
Sachs economists Broadbent and Daly in London. Lower spending means consumers
and companies don’t fear higher taxes, so demand accelerates. A smaller public
sector also helps reduce borrowing costs and makes economies more competitive as
fewer government workers lighten labor expenses." ("Cameron Bets on Growth From
Austerity as U.S. Delays", Simon Kennedy and Rich Miller, Bloomberg)

Cutting spending reduces economic activity and slows growth. The Bloomberg article
merely presents the rationale for class warfare.  Fiscal strangulation is not the path to
economic recovery. Still, the deficit hawks have mounted an impressive public
relations campaign and have powerful friends at the Fed, the Treasury, the White
House, and Brussels. In the U.S., President Obama has appointed former Republican
Sen. Alan Simpson to head a bipartisan commission to "fix the federal government's
long-term budget problems", which is code for gutting social programs. In the E.U.,
German Chancellor Angela Merkel has taken the lead promising to hack $80 billion
from the country's modest deficits. Even Tokyo, after enduring 15 years of
excruciating deflation, is planning to slash long-term government spending. The
groundswell for hair shirts is steadily growing increasing the probability of another
severe downturn.


Here's the problem: The bursting of the giant asset bubble pushed the economy into
a long-term slump that required emergency action by the Central Bank. Fed chair
Ben Bernanke's liquidity injections and zero rates helped to pull the financial system
back from the brink, but households and consumers are still deep in the red.  The
deleveraging process is ongoing and will last for years. Obama must either increase
government spending or succumb to grueling economic contraction.

  As of March, the average U.S. household’s debt-to-disposable income ratio was
122% considerably lower than its  peak of 131% at the beginning of 2008.
Economists believe that that number will eventually return-to-trend at 100% which
portends years of sluggish consumer spending and slow growth.   With more families
forced to cut back to patch their battered balance sheets, fiscal stimulus must
increase or the economy will slip back into recession. Belt tightening now will only
increase the deficits by reducing government tax revenues.  In a recent interview,
Nomura economist Richard Koo was asked if the US should try to reduce their deficits
by cutting back stimulus. Here's how Koo responded:

  "Not until private sector deleveraging is over. At present, private sectors in the US,
UK, Spain, Portugal, and Italy are still deleveraging. This means these countries
should not try to reduce fiscal stimulus. Any attempt to cut deficit in these countries is
likely to result in a weaker economy and a larger deficit as seen in Japan in 1997....
When private sector is deleveraging, money multiplier is negative at margin. No
monetary stimulus will work in such an environment where people are trying to
reduce debt, even with zero interest rates, in order to repair their damaged balance
sheets.

Until people realize that they have contracted a completely different disease called
balance sheet recession where the private sector is minimizing debt instead of
maximizing profits, a constructive policy dialogue is not likely to be possible. Once the
exact nature of the disease is understood, the remedy (sufficient and sustained fiscal
stimulus until private sector balance sheets are repaired) will become obvious to
everyone." ("Interview: Richard C. Koo, Nomura Research Institute", Acemaxx
Analytics)

Koo does not believe that the current recovery is self sustaining. The rebound is
stimulus-driven and merely reflects improvements in the financial sector (and the
markets) which plunged after Lehman Bros collapsed. The heavy-lifting of repairing
household balance sheets (which suffered losses of nearly $12 trillion) is still in its
early stages.  President Obama's $787 billion fiscal stimulus has helped a bit, but it's
mainly been used to pay unemployment claims, provide  tax cuts and to make up for
the losses in state revenues. And while it is not true that the stimulus "has done
nothing" as the deficit hawks claim (IHS Global Insight, Macroeconomic Advisers and
Moody's Economy.com all estimate it created around 2.5 million jobs.) its effects have
largely been canceled-out by the gigantic state budget gaps. Conservative economist
Bruce Bartlett explains in the Washington Post:


 "The Center on Budget and Policy Priorities estimates that in 2011, the states will
have to come up with a total of $180 billion. These budget shortfalls are the
equivalent of a massive anti-stimulus....And because they cannot run deficits to hold
them over until their economies improve, they're cutting services and raising taxes.
Using the data for 2009 and 2010, and then projecting for 2011 and 2012, the Center
on Budget and Policy Priorities expects the total state shortfall will reach $610 billion.
Because some of the federal stimulus dollars were saved rather than spent, the
effective stimulus we've had has been less than the $789 billion that's often touted. It
might even be less than $610 billion shortfall in the states. Which would mean the
anti-stimulus overwhelmed the stimulus. Or, you could look at it in reverse: Nick
Johnson, who directs the State Fiscal Project at CBPP, says that "the effect of the
federal stimulus was to wipe out the negative effect of the state contraction."("You've
seen the stimulus. Now, meet the anti-stimulus", Ezra Klein, Washington Post)

The Obama stimulus was a good start, but there's more work to be done. It
prevented a downward spiral of falling asset prices and  debt-deflation, but it wasn't
big enough to put a dent in skyrocketing unemployment or lay the groundwork for
another expansion. There needs to be a renewed commitment to long-term stimulus
until households regroup and the economy gets back on track.  Monetary policy
alone will not succeed. The monetary transmission mechanism is on the fritz so
reserves are piling up at the banks, but not getting into the hands of people who can
generate more activity.

Consumer spending is flat, home prices are set to fall, unemployment will likely edge
higher, private sector credit is still contracting, capacity utilization is far below pre-
crisis levels, the CPI is slipping,  and yields on US Treasuries are priced for deflation.
The government must pick up the slack or their will be a general fall in prices that will
trigger more layoffs, larger deficits, and social unrest. Premature fiscal consolidation
can have unintended consequences as noted by Richard Koo:

  "Pushing ahead with these misguided policies risks a collapse of social and economic
foundations and could even threaten the survival of democratic structures."