How We Got Here Matters

Time and again on his book tour for End This Depression Now, Nobel Prize winning economist and New York Times columnist Paul Krugman argues that the U.S. should spend more newly borrowed money to stimulate the economy immediately, asking “if not now, when?” on numerous occasions, commenting repeatedly that it is so “obvious” to him that this is what the U.S. government should be doing with the utmost urgency.

Krugman recommends that Washington borrow billions and billions more at today’s freakishly low interest rates to hire back laid off state and local public sector workers that state and local governments can no longer fit in their shrinking budgets (that, unlike the federal government, have to be balanced every year) and to begin spending money furiously to improve our roads, shore up our bridges, and, generally, make the country’s infrastructure more conducive to economic growth.

This is classic Keynesian economics and, on the surface, it seems to make sense - have the government spend during downturns because the private sector won’t or can’t - but then, when you consider how the nation collectively arrived at this juncture, maybe it would be better to think again.

Clearly, policymakers in the U.S. were not just casual observers of the inflating and collapsing asset bubbles over the last dozen years or so that have led us to our current predicament.

Why should they be trusted to plunge the nation further into debt and spend that money wisely?

Who’s to say that restoring 2007-era public worker staffing levels at state and local governments is the right thing to do?

And who’s to say that fixing potholes will have the sort economic impact that its proponents think it will for the economy as a whole?

Sure, economists will tell you that we must borrow and spend to stimulate the economy now and, at the same time, work to cut our debt load sometime in the future, but, it should be obvious by now that the nation has very little credibility on the latter and more of the former risks what could potentially be an even bigger crisis than the one we have now - when creditors balk and decide to no longer lend the U.S. money or, more likely, begin demanding much higher rates of return.  

Perhaps the best reason not to follow Krugman’s advice - and this seems to be the consensus view amongst the general public - is that the government would, in the long run, end up making things worse, not better.

To be sure, Wall Street, the mortgage industry, the home building industry, and homebuyers betting they could make back on the housing bubble what they lost on the internet stock bubble all played key roles in fostering credit and debt excesses that were sure to end badly.

But, the federal government was a major factor as well, allowing these asset bubbles to develop and then, disastrously, meet their pin.

In fact, they almost guaranteed this outcome in the 1990s by taking such actions as rolling back 1930′s era legislation like the Glass-Steagall Act that, effectively, turned Wall Street from a modest gambling parlor into a gigantic one, and the Federal Reserve made all that gambling much easier with its freakishly low interest rates for most of the last decade.

State and local governments were complicit in the housing bubble excess too.

I remember back in 2005, California state legislators were harping about the housing crisis - not that there was a housing bubble about to burst, but that no one could afford to buy a house anymore because, even with no money down, low or no interest loans where fogging a mirror was about all it took to qualify, prices had been bid too high.

Their solution at the time?

To somehow get that worker with a $50,000 a year salary into that $500,000 house by making already super-loose lending standards even easier.

These are the people who should now be showered with borrowed money from Washington in order to hire back public sector workers and fix the roads?

How we got here really does matter and there is far too little discussion on that subject.

As is the case for The Great Depression, in the view of most economists and policy makers, the history of our current depression begins with the bursting of the bubble and what happened before that seems to be unimportant. 

The only imperative is that the level of economic output should be restored to its former glory, regardless of how it got to that point.

Just the idea that, perhaps, that former glory was entirely unnatural and unsustainable due to a massive expansion of credit that accompanied some pretty important technical innovations is dismissed out of hand

A good example of this occurred just a few months ago when St. Louis Fed President James Bullard suggested just such a thing and was refuted by nearly every economist and policy maker in the land as detailed in When Models Trump Common Sense.

In a different world - one with less credit and debt accompanied by a smaller financial sector and a less interventionist central bank - more robust levels of government spending during economic downturns may be a good course of action. 

But, we don’t live in that kind of world anymore and it seems clear that the American public understands that.

The American people don’t know what should be done to fix things but they have an innate sense that piling more credit and debt on top of the existing pile of credit and debt isn’t the right approach.

This conclusion is made even easier to arrive at when considering that the last few years of work by the government and the finance industry have disproportionally benefited high income and high net worth individuals, not the 99 percenters.

A few months ago, when asked how he’d go about fixing things, GMO’s Jeremy Grantham quipped “Well, I wouldn’t start from here” and this is about as profound a piece of advice that anyone could offer at this time.

How we got here matters and not getting “here” again is probably more important than any other policy decision that will be made in the years ahead - more debt and credit is clearly not the solution.

More and more it seems that we just have to “take our medicine” and let markets come to some sort of equilibrium, perhaps enduring a lot more pain over the near-term in order to arrive at a more sustainable condition sooner rather than later.

The American people seem to understand this.

In fact, it’s all very obvious to them.

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6 Responses to How We Got Here Matters

  1. Mike June 21, 2012 at 11:06 AM #

    So, you’re arguing that the Keynesian approach is not necessarily invalid, but rather the mechanisms for implementing such a policy are flawed?

    Seems to me that you fix the mechanisms, not ignore the correct policy. We’ve done that before, why not now? The idea that the correct approach is doing nothing is really quite cynical and is part of the problem, not a solution.

    • DCX2 June 21, 2012 at 1:52 PM #

      One thing that always bothers me (and I’m sure I’ve ranted about it before in Tim’s comments) - “Keynesian Economics” is more than “deficit spend during recession”. That’s only half of it! The full theory is more generally “government exerting counter-cyclical pressure”.

      Whenever things are booming, taxes and interest rates are supposed to go up. This keeps the economy from “overheating” (aka bubbling!) The problem is that roughly half of our government has signed a pledge to never raise taxes - thus barring the government from properly implementing Keynes’ theory.

      So in that regard, I agree with both you and Tim; we got here through low interest rates and low taxes while the economy was booming. You can’t call the Keynesian approach invalid if the previous attempts to implement it were faulty.

    • Tim June 22, 2012 at 6:15 AM #

      The problem here is that the “mechanism fix” you’re suggesting would be something even more “draconian” than a balanced budget amendment, that is, some sort of legislation that would reverse the recession deficit-spending by using recovery surpluses to pay down the debt incurred during the slowdown.

      I think we’re beyond the point where anyone would believe that any Western government would do this, even if they went so far as to promise that they would.

  2. Redpath June 21, 2012 at 12:25 PM #

    Oherwise known as ‘dig a deeper hole’. If this doesn’t reek of desperation I dont know what does. Hang on to your hats folks.

    P.S. Can I get a Nobel Prize? They seem to be giving them to idiots and I certainly would meet any minimum requirement….

  3. News June 21, 2012 at 2:33 PM #

    We do have to do something. Otherwise we will become Japan. I think the way stimulus was done in 2009 with a lot of it benefiting unions and not the general economy makes many people question whether it worth doing it again. Having a stimulus to help teachers and firefighters keep their salaries does very little to reform our economy and create more innovation. Investing into industries such as solar is a good idea. Although Solyndra was not the best investment, as a whole, solar industry is very important for the future.

    Most of all we need reforms. We go far less reforms than I hoped for. Both parties still don’t get it. Although I have to say that Republicans really don’t get it. Most of them talk how we will get inflation and interest rates will go up and yet they don’t want the government to borrow at super low rates. The problem is not borrowing, but how the money is spent.

    If we could borrow 1 Trillion below 3% for 30 years, and invest into solar (subsidize solar panels made in US) and healthcare innovation in academia (give grants on academic institutions which will focus on how to really change medicine), we would get a huge return on investment.

  4. fresno dan June 22, 2012 at 4:37 AM #

    In general, I believe Keynes was right - government can spend during downturns. But government never seems able to cut spending or raise taxes during the booms, and therefore casts doubts on “managing” anything - it just seems to believe in something for nothing.

    For capitalism to work, it has to be a profit and LOSS system. The government won’t let those who caused the losses TAKE the losses. The problem with government is that it is corrupt - the people who believe in the credit models that JUST HAPPEN to result in ginormous bonuses to fianciers are in a big revolving door between the banks and the FED, Fannie, Freddie, and the obscure ones like the CFTC. And somehow, investors at banks should never take serious losses, cause the banks are TBTF. If the government handled the Titanic like it handled AIG, it would be throwing widows and orphans overboard to try and help keep the ship a float…

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