Great Depression 2.0.

Posted by John Malloy on 05/22/2010

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Mike Whitney
Information Clearing House
Deficits create demand. Demand generates spending. Spending generates economic activity. Economic activity generates growth. Growth generates jobs, increases government revenues, reduces deficits and ends recessions.

Simple, right?

When consumers have too much debt, they will not spend no matter how low interest rates are. This is not theory, this is fact.

If the government cuts spending at the same time as consumers, then overall spending declines and the economy slips into recession. This is what the deficit hawks want–a return to recession. This is politics, not economics.

KEYNE’S KOAN: Increasing the deficits, lowers the deficits

The deficit hawks say “You can’t solve a debt problem by adding more debt”. This is a very persuasive argument, but it’s wrong. Increasing the deficits, lowers the deficits. This sounds wrong, but its right. Here’s proof from a recent article by economist Marshall Auerback:

“Ireland began cutting back deficit spending in 2008, when its banking crisis began to spread and its budget deficit as a percentage of GDP was 7.3 per cent. The economy promptly contracted by 10 per cent and, surprise, surprise, the deficit exploded to 14.3 per cent of GDP.” (“The US is not Greece”, Marshall Auerback, counterpunch.org)

Ireland is not the exception. Ireland is the rule. A nation cannot starve itself to prosperity nor can it shrink its way to growth. Austerity is fine for monks, but bad for the economy.

Deficit cutting during a downturn creates bigger deficits, higher unemployment, greater economic contraction, and more suffering. Every country that follows the IMF’s prescription for belt-tightening, undergoes a mini-Depression. That’s because its bad economics (or, rather) politically-driven economics. By weakening the state, private industry and speculators hope to grab public assets on-the-cheap and force privatization of public services. These are the real objectives behind the austerity measures.

When the government is in surplus, the private sector must be in deficit. When the government is in deficit, the private sector must be in surplus. It’s that simple. So, when consumers and households must save to make up for lost equity and falling revenue, (such as, after the collapse of the housing bubble) the government MUST increase deficits to keep the economy running, to reduce slack in demand and to lower high levels of unemployment. Without Obama’s fiscal stimulus, the economy would not have produced 3 quarters of positive growth. The stimulus (and monetary policy) kept the economy from tipping into a severe recession. Had Obama followed the advice of the deficit hawks (many of who also supported Bush’s wars in Iraq and Afghanistan) the country would be mired in another Great Depression. This is worth considering when some Fox bimbo in a plunging-neckline says “The stimulus did nothing.”

Sovereign governments whose debts are paid in its own currency, are not like you and me. They are not fiscally constrained or required to balance their checkbook. Nor should they if it weakens the economy or increases unemployment. The government can spend without risk of going broke because the debt is owed to itself. Yes, this can create inflation when unemployment is low and there is too much money chasing too few goods. But that should not deter government from stimulating the economy when unemployment is 10%, underemployment is 20%, manufacturing is slow, housing is in a shambles, core CPI is below 1%, and the economy is teetering towards outright deflation. Deficits should be increased and sustained at a high level until unemployment and overcapacity begin to retreat. Economists know that consumer deleveraging is a long-term project, which means that government stimulus will be required for a very long time. Get used to it…

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Posted by John Malloy on 05/22/2010. Filed under International. You can follow any responses to this entry through the RSS 2.0. You can leave a response or trackback to this entry