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Regarding the Myth that Austerity promotes Fiscal Expansion

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August 04, 2011 – Comments (52)

Professor Bill Mitchell's site is something that should be on your daily reading list. His latest post is another in a long theme of posts dispelling the idea that austerity leads to 'fiscal contraction expansion'. If that were the case, then Great Britian's economy would be growing strongly right now based on their austerity implementation last year. If the theory was correct, then their GDP should have been increasing signficantly and Gilt yields should be going up (prices going down as investors want to put safe haven money into postively correlated economic assets). However, the exact opposite has been happening as has been evident for quite some time.

This line in his conclusion is a perfect summary: The evidence mounts – day by day – that the mainstream economic position is deeply flawed and incapable of resolving the economic disaster that its application caused.

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Day by day the evidence mounts
Posted on Thursday, August 4, 2011 by bill

http://bilbo.economicoutlook.net/blog/?p=15542

[excerpt]

I was looking at yields today and you cannot help noticing that bond markets are become more attracted to government debt each day. So much for the arguments we have been hearing ad nauseum over the last few years that governments were about to feel the cold hand of the markets who would punish them by dumping their debt unless they imposed harsh austerity. The problem is that the attraction of government debt does not signify that markets are rewarding governments for their fiscal austerity efforts. In fact, it is exactly the opposite. The markets are realising that austerity is now undermining economic growth and the claims by politicians and economists that we would enjoy a “fiscal contraction expansion” if only the government got off the backs of the private sector are now being revealed as lies. The world economy is tanking. Day by day the evidence mounts. The safest place to be when the economy heads south is in cash or government bonds.

Consider the following graphs which show the UK and US benchmark yield curve for today, yesterday and 1 month ago.



Then consider Japan’s yield curve – they are after all 2.5 times at least over the so-called default threshold public debt ratio that gets bandied around by commentators. Compare the vertical scale to that of the UK and the US.



Pause for a moment and reflect on what these graphs are telling us.

They are not telling us that the bond markets are happy that the British government is pursuing a harsh austerity program which is what George Osborne (British Chancellor) would like you to believe.

They are not telling you that the farcical debt ceiling debate in the US has destabilised bond markets who feared the US government would default.

They are not telling you that the bond markets expect galloping inflation to result from the higher than usual budget deficits that these governments are running.

They are not telling you that the bond markets expect interest rates to rise because the higher than usual budget deficits are competing for scarce savings and crowding out private spending.

They are not telling you that investors are buoyed by the fiscal austerity being imposed on economies all over the world and that they think private sector confidence is about to burst forth and fill up the spending gaps left by the declining government spending.

In the British case, the 10-year gilt yield dived to a “record low” yesterday such was the strength of demand for them from the bond markets.

As each day passes, the real economic news (decline of manufacturing, construction and services etc) gets worse in Britain and growth forecasts, already abysmally low, get revised downwards.

The market talk is about an “intensifying flight-to-quality flows supporting gilts”.

The same pattern is occurring in all the major government bond markets and has been consistent over the last month or more.

While the IMF and other right-wing think tanks control idiot politicians like ventriloquists and have them parrot mantras like “fiscal contraction expansion” … “austerity is pro-growth” etc the money boys and girls know otherwise.

52 Comments – Post Your Own

#1) On August 04, 2011 at 1:02 PM, JaysRage (89.80) wrote:

Wow.   This guy just doesn't get it.   

Austerity is a little bit like having surgery to fix something in your body or remove cancer.    It's short term pain to set yourself up for long-term success.    In the short term, you have to heal.   Then you have to build up your muscles and bone strength again.   Then, instead of limping around and using pain meds, you can actually run and jump.    However, in the short term, flat on your back seems worse than limping around.   We've become addicted to the pain meds, and we don't realize that they are not actually fixing the problem.  In fact, they are doing long-term damage to our body (the economy) 

Our economy was just in a trainwreck three years ago.   Lots of surgery is still needed.   

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#2) On August 04, 2011 at 1:07 PM, binve (< 20) wrote:

JaysRage ,

Your comment is a lot of idelogy and rhetoric that doesn't actually explain anything. Analogies do not make an arugment. You have not demostrated why his position is incorrect.

In fact, they are doing long-term damage to our body (the economy) 

Demonstrate this point.

Instead of rhetoric, read this post to undestand the nature of budget deficits and how they fit in the current macroeconomic environment: http://caps.fool.com/Blogs/why-deficit-spending-and/621467..

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#3) On August 04, 2011 at 1:17 PM, TheDumbMoney (47.10) wrote:

While I share binve's belief about the horror of government austerity in time of recession, I think what we are mostly seeing right now is blowback from the Euro debt crisis.  Lots of events are time-corrollated though, and it is impossible to separate out the impact of the debt ceiling farce, and general economic worries.  This separation is made even more impossible by all of the feedback loops (fear creates economic harm and economic harm create fear, etc.). 

Overall, I think it is inarguable that Republicans' apparent willingess to default on U.S. debt created a huge amount of unecessary fear, and it is having a real impact.  At the same time, Obama's prime-time statement that he couldn't gaurantee social security checks would go out on August 1st was hugely irresponsible as well.  At the end of the day, neither side properly grasped the psychological impact their actions could have. 

But on balance, I think when people are worried that speculators are going to take a major run at Spain and Italy (the way the took a run at Bear Sterns and Lehman in 2008), that trumps.  I think this may explain the slump after the debt-ceiling debate concluded:  market participants, all of whom were transfixed by that, suddenly realized where the really immediate problems lay:  Eurozone debt, and to a lesser extend the slowing U.S. (and consequently world) economy, which will, as a bonus, exacerbate the Eurozone debt problem.

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#4) On August 04, 2011 at 1:28 PM, TheDumbMoney (47.10) wrote:

Further supporting my Eurozone hypothesis is that we are witnessing a liquidity event today. 

That is, in my view, why the dollar is rallying, and some of the worse market losers today are highly-leveraged (and often bought on margin) gold miners.  Gold itself is not plunging as much because at the end of the day I now think it is corrollated most closely to real interest rates, or expectations of them, which have not changed as much. 

But I like the rest of you am a complete non-expert, bloviating, farting in the wind, etc.

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#5) On August 04, 2011 at 1:32 PM, binve (< 20) wrote:

dumberthanafool,

Those are very good observations. I agree with you that the current stock market pullback is a reaction based on a few uncertainties, but doesn't warrant a 'crash' here.

The immediate danger was that if this idiotic and made-up debt ceiling 'crisis' did not come to agreement, then the US governmetn would go into 'balanced budget mode'. This would have cut trillions in deficit spending this year and would be been the most precipitative 'anti-stimuls' action ever. And I agree, both Reps and Dems handled this like a bunch of childish idiots.

Fortunately that did not come to pass, and it looks like there there will be some cuts, but much of the deficit will be intact. And equities can still grow in such an environment (Mosler has some good thoughts on that here: http://moslereconomics.com/2011/08/03/post-debt-ceiling-crisis-update-2/).

So there is still some investor 'nervousness' but that should be abating.

But there still is stalling GDP and unemployment is ticking back up and a number of 'non-growth-friendly' development that might mean that equities just hold this level instead of growing or crashing signficantly from here.

But I agree, the wildcard is the Euro debt crisis (which is very real based on their currency system, as opposed to the US debt crisis which is entirely self-imposed and fictional). Most developed econmies could feel the effects of a funding crisis in Italy (or any other Euro country for that matter)..

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#6) On August 04, 2011 at 1:36 PM, JaysRage (89.80) wrote:

At least people are now calling our current situation a recession again.  That's a start.   We can stop the fabrication that we're in some sort of stable recovery.   The entire recovery was based on deficit government spending.    

Long-term damage to the economy = Debt that is too large to service = debt downgrade = increased expense of debt = continued economic demise. 

The article is absolutely correct.   Austerity in the short term will hinder the growth of an economy as measured by GDP. 

I do not measure the health of an economy by GDP.   I measure it by the sustainability of economic growth.  Debt spending is not sustainable, especially at the levels we're talking about.   We're talking about cutting government spending that is well beyond what it takes in.   This is to support an economic fantasy that the spending levels in 2008 were somehow normal and not that they were supplemented by deficit government spending and inflated home price equity spending.  

What if I told you that the 2008 GDP was a juiced up fabrication to begin with and there is no reason that we should want to prop anything up to its previous state and that contraction to a sustainable level is healthy?

 

 

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#7) On August 04, 2011 at 1:41 PM, JaysRage (89.80) wrote:

I would be the most unelectable person on the planet because I believe that the government needs to shrink drastically, and I think that taxes need to increase, and I think that social security and medicare ages both need to increase at least 3 years in eligibility.   That means that I would pretty much tick off every portion of society.   

Vote JaysRage for worst political platform ever. 

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#8) On August 04, 2011 at 1:43 PM, davejh23 (< 20) wrote:

Binve - To be fair, many of your recent posts have been laced with ideology as well.  These hints from the bond market alone do not prove any economic theory.  It's difficult to take an author seriously that calls out one specific ideology and purports that strict austerity is the "mainstream economic position" when that's far from the truth...at least in the US.

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#9) On August 04, 2011 at 1:46 PM, TMFBlacknGold (98.76) wrote:

What if I told you that the 2008 GDP was a juiced up fabrication to begin with and there is no reason that we should want to prop anything up to its previous state and that contraction to a sustainable level is healthy?

I wholeheartedly agree. I liken it to the housing market. Analysts parade the streets yelling "No growth in the housing market!" and talk about a "housing recovery". Um....housing was inflated. The levels we are at now are a correction. I shudder everytime I read a variation of the line "...housing prices...pre-recession levels...". We call these people experts? Ha!

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#10) On August 04, 2011 at 1:47 PM, TheDumbMoney (47.10) wrote:

JaysRage,

With due respect, I think your entire post #6 completely ignores the importance of feedback loops, of confidence begetting confidence, of fear begetting fear.

Obama's mistake was not stimulus.  Obama's mistake was focusing on healthcare (because he egotistically wanted to enact "his platform") rather than what he should have done. 

What we really needed in this country starging in early 2009 was half-Paul Krugman and half-Paul Ryan.  In short, the impossible.

We needed:  1) HUGE immediate stimulus, at least a trillion dollars (the Krugman part), to increase immediate confidence and jump-start the economy, combined with.

2) HUGE long term deficit reduction measure, making concrete plans to cut at least five or six trillion over the long term, starting years down the road, mainly through entitlement cuts, though also via tax increases.  This we needed to combat the very real hit to confidence that you point to that arose because of long-term worries.

That is what we needed.  Rebublican idiocy stymied the first of those, and Democratic idiocy stymied the latter.  As we usually do, we limped along with half-measures.  Instead of compromising by taking the best ideas of both parties, which is what should happen, our disfunctional political system compromised by implementing them in insufficient half measures, first with insufficient immediate stimulus, and on August 2 with insufficient long-term cuts.  It's a two-fer of failed leadership and Congressional and executive idiocy. 

Anyone here or anyone else that tries to blame the "other side" entirely is either selling an ideology or is genuinely a moron.

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#11) On August 04, 2011 at 1:48 PM, davejh23 (< 20) wrote:

FWIW, I'm taking your change in tone (backing off the EW stuff and calling for stable markets) as a sign that the market is actually going to crash now.

I have to agree with JaysRage, you can't measure the health of an economy by the GDP number alone.

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#12) On August 04, 2011 at 1:48 PM, TMFBlacknGold (98.76) wrote:

I would be the most unelectable person on the planet because I believe that the government needs to shrink drastically, and I think that taxes need to increase, and I think that social security and medicare ages both need to increase at least 3 years in eligibility.  That means that I would pretty much tick off every portion of society. 

You have my vote.

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#13) On August 04, 2011 at 1:50 PM, TheDumbMoney (47.10) wrote:

Jays, based on your post #7, which you must have written while I was writing my post, our actual solutions are quite similar.

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#14) On August 04, 2011 at 1:56 PM, binve (< 20) wrote:

JaysRage,

We can stop the fabrication that we're in some sort of stable recovery.   The entire recovery was based on deficit government spending.  

Agreed, the 2002-2007 horizontal credit boom caused the private sector to take on loans so that their Debt/Income (as a whole) >110% (the distribution is actually worse for middle income). 2008-20xx is the aftermath (credit bust) of that horizontal boom (becuase horizontally created money is an asset for the borrower but a liability for the lender and must be paid back). Governement deficit spending since 2008 has lessened the effects of this credit bust, making it a counter-cyclical response.

Long-term damage to the economy = Debt that is too large to service = debt downgrade = increased expense of debt = continued economic demise. 

This is incorrect and completely unsubstantiated. The US Government is sovereign issuer of the US Dollar and can never 'not' have dollars. It can *always* 'afford' afford to create new Dollars to honor US Dollar denominatied obligations at any time. Always. Neither funds nor taxes 'fund' the US government. see here

I do not measure the health of an economy by GDP.   I measure it by the sustainability of economic growth.

Okay. Define 'sustainability of economic growth' and provide a measure of it.

Debt spending is not sustainable, especially at the levels we're talking about.   We're talking about cutting government spending that is well beyond what it takes in.

Again, competely incorrect. See above comment and link. And also answer this question: "If America faces a funding crisis (not able to sell 'debt' to finance its spending) then how did the non-Government sector (private domestic and foreign sectors) get the money to buy the debt in the first place?"..

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#15) On August 04, 2011 at 1:59 PM, whereaminow (24.34) wrote:

binve,

On my flight to Maryland, I read your "dissertation" (ROFL). I'm about to hop on a plane to Alaska in a few hours and write my response.

Need you to answer a quick question:

Do you take the business cycle as a given?

I notice that in your dissertation you used the Schumpeter-ian version of the cycle (which takes the boom as a given - and a positive - and the bust as an unfortunate second wave) and the Schumpeter-ian term "creative destruction."

David in Qatar

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#16) On August 04, 2011 at 2:01 PM, TMFBlacknGold (98.76) wrote:

I do not measure the health of an economy by GDP.   I measure it by the sustainability of economic growth.

Okay. Define 'sustainability of economic growth' and provide a measure of it.

GDP is a very old, colonial metric that worked fine for, well, colonial powers. In today's modern global economy it doesn't fit so nicely. For instance, it doesn't take into account PPP.

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#17) On August 04, 2011 at 2:08 PM, binve (< 20) wrote:

davejh23 ,

>>Binve - To be fair, many of your recent posts have been laced with ideology as well. 

Fair enough. I try to cut it out, but I doubt I am completely sucessful. 

This post however specifically is a non-ideological argument looking at debt / deficits / inflation from a rigorous viewpoint: http://caps.fool.com/Blogs/why-deficit-spending-and/621467

>>These hints from the bond market alone do not prove any economic theory. 

I agree they don't by themselves, but that is not the 'whole' of Prof. Mitchell's argument (nor did either he or I imply that). If you want to level a criticism like that, then you really need to read more of his work first. 

>>It's difficult to take an author seriously that calls out one specific ideology and purports that strict austerity is the "mainstream economic position" when that's far from the truth...at least in the US.

Austerity *is* in the mainstream economic positon (you are throwing in the word 'strict'). The majority of mainstream ecnomists think that the government debt size is a 'problem'. Most are 'hawkish' (it is an *immediate* problem), the rest are 'dovish' (It is a problem. But the economy is a more serious problem. Therefore we can deal with the debt 'problem' later). So mainstream economists advocate that we have to endure some form of austerity at some point (either sooner or later).

The very tiny minorty call the idea of 'debt being a problem' absurd. Debt is very a problem per se. It all depends on the underlying state of the econmy and resource utilization (especially labor) in order to produce economic output. Money is never a real constraint, only resources are.

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#18) On August 04, 2011 at 2:13 PM, leohaas (32.36) wrote:

Excellent post. Again. Keep 'em coming.

I do see a strange thing happening here. Though I disagree with JaysRage strongly on his reasoning, I do agree with his political platform to some degree. In the long run, cutting spending, increasing taxes, and increasing the social security and medicare eligibility ages are needed! 

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#19) On August 04, 2011 at 2:14 PM, binve (< 20) wrote:

davejh23

backing off the EW

http://marketthoughtsandanalysis.blogspot.com/

as a sign that the market is actually going to crash now.

Feel free to use me as a conincident or contrarian indicator. I don't care either way..

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#20) On August 04, 2011 at 2:21 PM, binve (< 20) wrote:

whereaminow ,

Hey David, hope you are having a good trip!

I read your "dissertation" (ROFL)

:)

Do you take the business cycle as a given?

Yes, I think there are and always will be business cycles, despite the myth of the Great Moderation. The government can choose to participate them either counter-cyclically (damp the osciallations) or pro-cyclically (amplifiy the oscillations). That was one of the ideas I was exploring in my post, even if I didn't spell it out in exactly those terms

(which takes the boom as a given - and a positive

I don't take a boom as a positive necessarily. Booms and bust are economic dislocations, and as such there are always winners and losers in any event. Booms tend to favor risk taking and speculative investors, Busts tend to favor conservatism and bondholders.

We see cycles all the time (the yearly cycle being the most obvious), in all kinds of human behavior, our lives, and our endeavors. Cycles are not 'good' or 'bad', they are just a fact of life...

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#21) On August 04, 2011 at 2:22 PM, binve (< 20) wrote:

leohaas ,

Thanks, will do :).

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#22) On August 04, 2011 at 2:24 PM, binve (< 20) wrote:

BlacknGold ,

Is GDP perfect? Absolutely not.
Is GDP irrelevent? Absolutely not.

However that wasn't the purpose of the comment, which was responding to:

I do not measure the health of an economy by GDP.   I measure it by the sustainability of economic growth..

That's fine. Define it and provide a metric if one proposes an alternative.

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#23) On August 04, 2011 at 2:24 PM, whereaminow (24.34) wrote:

binve,

Yes, I think there are and always will be business cycles

Ok, well are you married to this position?  If I show you that it's wrong, then what? 

David in Qatar

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#24) On August 04, 2011 at 2:27 PM, binve (< 20) wrote:

whereaminow ,

David, I think you have know me long enough to know that I am not married to any position.

I will take anybody's argument at face value and consider the merits. I think I have demonstrated this. I have been continually updating my economic understanding and analysis in the face of new, better and more compelling information.

If you have an compelling argument I am always happy to listen to it...

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#25) On August 04, 2011 at 2:36 PM, whereaminow (24.34) wrote:

ok, good.

That will be the crux of my rebuttal.

Whether you agree or not, you are going to learn that the Austrian School position is that the business cycle is not a given, and hence it is not ideology that drives Ron Paul and Austrians to advocate for lower government spending, but economic law.

So maybe we can at least get you to stop using this Regressive tactic of labeling all others with whom you disagree as ideologues.  We can hope.....

David in Qatar

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#26) On August 04, 2011 at 2:38 PM, binve (< 20) wrote:

So maybe we can at least get you to stop using this Regressive tactic of labeling all others with whom you disagree as ideologues.  We can hope.

Reprimand issued .... and accepted. 

You are right, I am being unfair / unobjective in some of my commentary. I will promptly stop.

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#27) On August 04, 2011 at 2:42 PM, whereaminow (24.34) wrote:

no prob

(i'm as guilty as any of doing that, but i just have to point out it doesn't apply to my main man from lake jax, the great doctor of liberty.)

David in Qatar

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#28) On August 04, 2011 at 2:45 PM, TMFBlacknGold (98.76) wrote:

Beyond GDP.

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#29) On August 04, 2011 at 2:47 PM, TMFBlacknGold (98.76) wrote:

Btw binve, I'm not arguing with you as I also follow Mitchell's site. You are right that it is not perfect, yet not totally dispensible.

Keep up the thought-provoking posts!

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#30) On August 04, 2011 at 2:56 PM, binve (< 20) wrote:

BlacknGold,

Thanks for the link. Thanks and will do!..

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#31) On August 04, 2011 at 3:12 PM, eldemonio (98.61) wrote:

Hello Fellow IPAer,

My brain hurts after reading your blog and comments, so take it easy on me.

While I agree that austerity measures do more harm than good during down cycles, shouldn't our ultimate goal be to only spend what we bring in?

Aren't there any negative consequences to deficit spending without end?

PS - Green Flash West Coast IPA is a must have.

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#32) On August 04, 2011 at 3:42 PM, binve (< 20) wrote:

eldemonio ,

Hey IPA man!

My brain hurts after reading your blog and comments, so take it easy on me.

No problem :)

While I agree that austerity measures do more harm than good during down cycles, shouldn't our ultimate goal be to only spend what we bring in?

Yes, I think it should, *but* it is because of what that means from a sectoral balance viewpoint. Most of what I am talking about comes from here: http://caps.fool.com/Blogs/why-deficit-spending-and/621467.

This equation is defined in the link above:

(G-T) = (S-I) - (X-M)

This is the macroeconomic sectoral balance equation. What this says is Net government spending (G-T, which is spending minus taxation) equals Net private savings (S-I, which is savings minus money spent on investment) minus net exports (X-M, exports minus imports, or the current account).

For a government to run a balanced buget under "stable" condictions, this means that the private domestic sector savings is equal to the current account deficit.

With a current account deficit that is positive (net importing), then by definition the private domestic sector is net spending (which *cannot* happen indefiintely, the meand private sector debt/income -> infinity)

With a current account deficit that is negative (net exporting) then the private domestic sector is net saving.

In an 'ideal' world (in my view at least), there would be international trade, but all current accounts for each country would be balanced (that is all exports would be balanced by the same size of imports). Large trade imbalances are a source of friction and instability. Just think about the US's tenuous oil position and this should be self-evident.

So, if the current accout balance was 0 (X-M = 0), and the Government balance was 0 (G-T = 0), then the private sector net savings are zero (S-I = 0), or stated another way the private sector was investing as much as they were saving.

Now there are some conditions on where this stable situation can be reached. If the economy is operating near full capacity. If we have an economy running near full capacity, high utilization of resources (including and most especially employment) => low unemployment. This means that all resources in the economy are fully utilized and producing econmic output. This would be the ulimate expression of a balanced economy.

And I would argue that this is the goal we should be trying to achieve.

However, we likely cannot meet this equilibrium statically, and so the Government net spending postion should adjust to periods where savings doesn't exactly equal investment and where exports does not exactly equal imports. But if we are operating near full capacity at full employment, then over a 'cycle' the government net spending position will be zero.

Aren't there any negative consequences to deficit spending without end?

Yes. Demand pull inflation.

Demand-pull inflation is caused by too much government spending when the economy is operating near full capacity. If we have an economy running near full capacity, high utilization of resources (including and most especially employment) => low unemployment and a positive current account, then a Government Budget Deficit (G-T > 0) is exactly the *wrong* position for the government to take. Because all resources are already bid for at the prices where they produce useful economic output. Further increase of net financial assets into that environment does not cause any further economic output to take place it just raises the general price level across all components of the CPI index.

PS - Green Flash West Coast IPA is a must have.

Right on! I haven't seen it, but I will ask my store to start carrying it. Thanks man!..

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#33) On August 04, 2011 at 5:09 PM, JaysRage (89.80) wrote:

Debt spending is not sustainable, especially at the levels we're talking about.   We're talking about cutting government spending that is well beyond what it takes in.

Again, competely incorrect. See above comment and link. And also answer this question: "If America faces a funding crisis (not able to sell 'debt' to finance its spending) then how did the non-Government sector (private domestic and foreign sectors) get the money to buy the debt in the first place?"..

All of the evidence is that the U.S. is having no problem selling its debt, so the evidence is completely against me that the U.S. is going to eventually pay the piper for printing money.   I would argue that U.S. Treasuries are already in a bubble because there are a lot of people and sovereigns playing old tapes about U.S. Treasuries as a safe haven.    Personally, I think the U.S. is playing a pretty dangerous game of chicken on how far they can push down the value of the dollar without reaching the tipping point of losing its value as a reserve currency.   Printing money does eventually reach an inflationary endgame.  In the case of the U.S., it will be magnified, because U.S dollars and treasuries are currently over-represented as reserve currencies. 

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#34) On August 04, 2011 at 5:36 PM, Frankydontfailme (28.15) wrote:

Binve, I know that you already have a backdoor for my coming comment, the confidence you show in your models disturbs me. I agree that your models are clever and logical, but I believe them to have little relevance to reality. While you say things to the affect of 'if governments don't follow these theories properly, there's nothing MMTers can do about it- bad policy is bad policy regardless of the monetary system). I apologize if I sum you up incorrectly....

The problem is governments do see treasuries as debt. China does get pissed when US devalues. While I get that you would like to spread these idea and hope they catch on, you understimate the importance of human psychology. People think excessive debt is a bad thing. They think money printing is a bad thing. They don't like the idea that a nation can infinitely print. They are not crazy.

I guess I'm ranting. Sorry. Your posts have helped me understand why an expansion of the monetary base doesn't necessarily cause inflation. I wish you'd add a disclaimer relating to how these theories are potentially irrelevant if human psychology takes over, the rules change (desperation leads Bernanke to allow reserves to enter the economy somehow), and or China gets pissed.

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#35) On August 04, 2011 at 5:57 PM, binve (< 20) wrote:

Frankydontfailme,

I am a mechancial engineer. I perform thermal and structural analysis in the aerospace industry. I use models on a daily basis to predict all kinds of physical phenomena. I know a little something about the uses and abuses of models: Of Modeling, Risk, Financial Innovation, and Liquidity Crises - http://caps.fool.com/blogs/of-modeling-risk-financial/344745.

The test of any good model is its general usefulness: Does it work over a wide range of conditions? Or does it have to have lots of 'correction factors' to account for special conditions.

That is what makes MMT models useful. Everything is built in balance from the ground up.

Mainstream ecnomic models, on the other hand, are based on a bunch of ad hoc correlations ("Phillps curves" and a bunch of other nonsense, leading to concepts like NAIRU which is even bigger nonsense).

you understimate the importance of human psychology.

I do absolutlely nothing of the sort.

China might get pissed. China might sell its treausuries. China might stop trading with the US. All of these are possibilities.

Are any of them the death of the US economy? No.
Will the US undergo a 'funding crisis' if China does not buy our Treasuries? No.

Imports are a real benefit, but if the US had to start making its own stuff because China wouldn't sell us anything, then we would lose out on that benefit in the short term. But in the long term we would adapt, become more self-sufficient again, and I think that would be a good thing...

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#36) On August 04, 2011 at 7:08 PM, Frankydontfailme (28.15) wrote:

You sufficiently rebutted my rant; at least for now.

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#37) On August 05, 2011 at 8:19 AM, JaysRage (89.80) wrote:

Are any of them the death of the US economy? No.
Will the US undergo a 'funding crisis' if China does not buy our Treasuries? No.

I'm not with you on this one, and I think it's the crux of our difference of opinions.   Loss of the U.S. dollar and treasury as a form of reserve currency would be the death of the U.S. economy as we know it.   We would trudge along as a second-tier economy, sure.     

What is your definition of a "funding crisis"?   If the U.S gets dropped as reserve currency, I would definitely expect a funding crisis.   Who absorbs a world's worth of U.S. Treasuries? 

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#38) On August 05, 2011 at 9:48 AM, Frankydontfailme (28.15) wrote:

I hear you JaysRage but he doesn't believe Treasures fund anything and has good reason to think that. 

Even if he's right, it doesn't change that fact that China sees USTs as funding us and China pissed right now so will demand higher interest eventually. We will have to print to pay.  

Also, nevermind inflation, if people lose faith in the dollar our economy is screwed. 

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#39) On August 05, 2011 at 11:25 AM, leohaas (32.36) wrote:

Great discussion. So far, binve 1, all others 0. But maybe that all changes when we all learn that the Business Cycle is nonsense?

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#40) On August 06, 2011 at 4:48 PM, JaysRage (89.80) wrote:

S&P did the unthinkable and downgraded UST.   Should be interesting. 

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#41) On August 06, 2011 at 5:46 PM, Frankydontfailme (28.15) wrote:

Score 1 for my reality trumping theory....

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#42) On August 06, 2011 at 6:24 PM, Earendil (< 20) wrote:

Binve, I love your essays on how the monetary system works, and agree with your perspective on how a fiat money system should operate (though, of course, the US, for unknown reasons – possibly due to the desire to introduce “checks and balances”, such as we have just seen in the debt ceiling debacle – has legally constrained its operations of the fiat money system to operate like a simulation of the old gold standard, rather than in the simpler ways it could be managed).

 

A question, related to your statement in comment #32, that you think the governments ultimate goal should be to spend only what it ‘brings in’ (in taxes) (on average, with some juggling over the cycles).   This would imply a static money supply, as under fiat, government creates money by spending and eliminates money through taxes.  As, on average, the population and the economy are growing over time, wouldn’t this static money supply be ‘deflationary’?  There would be fewer and fewer dollars per person over time, and fewer and fewer dollars to support each ‘unit’ of economic activity.  Unless the velocity of money constantly increased to compensate, it would seem that this must result in ‘deflation’.

 

Instead of having a goal to spend only what it ‘brings in”, wouldn’t a more “ideal” goal be for the government to always try to spend slightly more than it brings in?  Just enough so that the money supply grows at the same rate as the economy?

 

Interested in your perspective on this.

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#43) On August 06, 2011 at 7:08 PM, binve (< 20) wrote:

Earendil ,

Thanks man! I appreciate the feedback and the questions. Allow me to expound.

First, you should read this if you haven't (http://caps.fool.com/Blogs/why-deficit-spending-and/621467), but it does sound like you already have.

I don't think a goal of a blanced budget (or similar to what you are describing, I will get to that in a minute) is a worthwhile goal in and of itself. The point of my comment in #32 was to say that the real goals of any economic policy should be: Full utilization of resources available, including and most especially employment (-> low unemployment), maximal output of economic activity based on that resource utilization, and (because I believe it promotes less international friction) a balanced current account.

If these are achieved, then a government can run a balanced budget, as I described in #32. So it is imperative to see that there is nothing desireable about a balanced budget for its own sake, but is instead a reflection of a stable and maximized economy. Everybody who is trying to balance the budget in the current environment is saying that the effect will beget the cause, and I say that is utterly flawed thinking.

Regarding your observations: As, on average, the population and the economy are growing over time, wouldn’t this static money supply be ‘deflationary’?

You are 100% correct! I was using a 'balanced budget' as an analogy to show the types of policy and econonmic activity which should be the goals.

So once an economy achieves full employment and full resource utiliization, you have two basic options:

1) Keep the net financial assets (accumlated previous government spending positions) constant which will tend to put downward pressure on prices over time as the population grows

2) Keep the net financial assets growing at the same rate as population growth.

In both cases, the income will not be evenly distributed within the economy (it never will be in any case). If you take option 1 to an absurd extreme: you start with 1000 people and 1000 dollars at time=0 and at time=t you have 1000000000 people and the same 1000 dollars. Which doesn't seem to make much sense. But taken to an even more absurd extreme, the population of the US grows infinitely which obviously doesn't make any sense either.

This is in my view is putting the cart before the horse. I would much rather worry about promoting policies that achieve the goals of: full resource utilization full employment, maximal output, and a balanced current account. Then we can worry about a 'full capacity money growth' policy afterwards.

Thanks for the good comments!.

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#44) On August 06, 2011 at 11:27 PM, whereaminow (24.34) wrote:

#39) On August 05, 2011 at 11:25 AM, leohaas (95.92) wrote:

Great discussion. So far, binve 1, all others 0. But maybe that all changes when we all learn that the Business Cycle is nonsense?

You gotta love how Regressives try to frame the discussion even before they hear the other side of the argument.

Binve, the one thing I always hated was people that attacked my position without taking the time to study.  I'm going to slice you to pieces, but you will at least have the honor that I never received from people like leo and Jakila and dumberthan.  I will at least have read your ideas.

Now, I'm off to eat another huge helping of Alaskan crab, take down a few more I.P.A.'s and enjoy this awesome countryside.  Will holla soon!

David in Qatar

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#45) On August 07, 2011 at 12:40 AM, binve (< 20) wrote:

whereaminow ,

Huh, this is really an unfortunate tone that is being taken.

I'm going to slice you to pieces

You may disagree with any particular stance that I have, and vice-versa. But at least we have debated in good faith.

I have never wanted to attack you or 'slice you to pieces'.

I am glad you are enjoying Alaska.

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#46) On August 07, 2011 at 12:49 AM, binve (< 20) wrote:

David,

We also had this conversation just a few days ago. We are all trying to learn, not score points. http://caps.fool.com/Blogs/the-danger-is-from-the/620224#comment620982.

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#47) On August 07, 2011 at 12:11 PM, Earendil (< 20) wrote:

Binve,  Exploring your statement, “I would much rather worry about promoting policies that achieve the goals of: full resource utilization full employment, maximal output, and a balanced current account. Then we can worry about a 'full capacity money growth' policy afterwards,” I was wondering what effective policies might look like.

 

Ignoring the political feasibility of implementing policies, I thought it might be interesting to propose some strawmodel policies and see what people thought the pros and cons might be.

 

Here is an example:  Strawmodel Policy:  The government to give $50,000.00 to every US taxpayer (with strings attached).  Conditions might be: 1.  The money must be used first to pay debts if the recipient has any debts; 2.  If no debts, or if some money is left after paying debts, 80% must go into a retirement account (if recipient is under retirement age) or be used to buy an annuity (if recipient is over retirement age).  3. Remaining money can be spent or saved as desired by the recipient.

 

As a “thought experiment”, what might be the pros and cons of such a policy?

 

Some possible pros:  It would recapitalize the household sector and greatly reduce household indebtedness.  It would reduce risk to banks and lenders, turning many dodgy loans into paid in full.  It would immediately stimulate the economy with the up to $ 10.000 that each non-indebted taxpayer could spend or save immediately.  It would boost retirement savings, taking some pressure off entitlements such as Social Security.

 

Some possible cons:  It would be inflationary (a large boost to the money supply), but how inflationary?  Might the strings attached slow and spread the flow of the new money into the economy?  If it was difficult for the household sector to quickly run up new debts, (possible ancillary policies requiring limiting all asset secured loans to 80% of value, setting stricter credit limits on unsecured loans, etc.) how inflationary would it be, and how would that inflation manifest?  It would create a potential new “moral hazard”, (A belief in the household sector that unsustainable debts could safely be run up again, in the expectation of another government bail-out).

 

That’s only a few of the possible pros and cons.

 

I would be interested in others thoughts on the pros and cons of this strawmodel policy, and in other strawmodel ideas for possible policies (conventional or un-conventional) aimed at Binve’s goals of, “full resource utilization full employment, maximal output, and a balanced current account.” 

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#48) On August 07, 2011 at 12:42 PM, binve (< 20) wrote:

Earendil ,

I am not a big fan of that approach. The government bailed out Wall St. and solved nothing (they could have guaranteed all FDIC deposits and even a lot more private holdings while still resolving those institutions during the crisis). And while I think bailing out Main Street is better than bailing out Wall Street, bailing out is bailing out and encourages exceptionally bad behavior. Wall Street is back to all of the same tricks that led up to the crisis because they emerged unscathed! They housing bubble was built of reckless debt to income decisions by people, and the last thing that we should do would be to encourage that behavior again. In fact, if you think about the analogy, this would be like sending each person in the country an unemployment check (employed or not).

We need Government spending, because private spending and demand is so bad right now and spending = income. But instead of just giving the citizens money directly, the only real solution is job creation. Jobs directly aimed a producing a more stable economic environment.

That is precisely what I discuss in Section 6 of this posthttp://caps.fool.com/Blogs/why-deficit-spending-and/621467.

Government spending must be 'jobs rich' (as compared to the bailouts and support of Wall St. which was extremely 'jobs poor'). I think it is also smart to target parts of the economy that give us problems over and over (dismantiling of 'too big to fail' and implementation of a real energy independence strategy), as I discuss in the previous link..

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#49) On August 07, 2011 at 2:58 PM, Earendil (< 20) wrote:

 

Hi Binve,  I’m also not particularly fond of the strawmodel approach.  Like you, I guess the “moral hazard” is one of its main drawbacks.  I am curious, however, about what might be the implications of such an approach on inflation?

 In a fiat money system, the government should be able to spend whatever it wants, unconstrained by tax or borrowing considerations.  The only constraint, or real impact of Government spending seems to be the impact on inflation or deflation caused by net government spending or saving.

If the government spends more than it 'takes in', thereby creating jobs, stimulating the economy, etc.  It is also boosting the money supply, thereby eroding the value of savings, rewarding profligate borrowing, etc. etc.  

 Do you think this 'inflation' effect only really hits hard when the economy is near full utilization, or does it occur at all times?  Are some policy responses more or less likely to have harmful money supply effects?  How should an 'Ideal' government policy balance money supply goals with other economic goals like stimulus? 

 

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#50) On August 07, 2011 at 3:18 PM, binve (< 20) wrote:

Do you think this 'inflation' effect only really hits hard when the economy is near full utilization, or does it occur at all times?  Are some policy responses more or less likely to have harmful money supply effects?  How should an 'Ideal' government policy balance money supply goals with other economic goals like stimulus?

The long term trend  of Inflation in response to cumulative deficit spending  positons (increase in net financial assets over time) is the major theme of this post: http://caps.fool.com/Blogs/inflation-and-asset-price/592721.

However, that means that most people assume that deficit spending => inflation at all times. And that is not the case and it is not that simple. 

That was then one of the major themes of this post: http://caps.fool.com/Blogs/why-deficit-spending-and/621467. Because many people confuse inflation to deficit spending (vertical money) and inflaton due to  loans and margin (horizontal money). Also there is confusion due to demand-pull and cost-push. And even more confusing is that there is some combination of all of these acting all the time. The price response of any one item (say oil) is never independent of all four. But in understanding how each one manifests, one can look at primary causes and effects vs. secondary ones. (A sensitivity study if you will).

So when looking at inflation responses in the current defecit spending environment, demand is a huge factor. And the fact that we have high unemployment and the private sector in a balance sheet recession means that any deficit spending now means *in general*  that prices will not increase as much as they would in the economy was healthier.  But of course for any asset, both horizontal money and price setting can play a factor independent of the government spending position. See comments #13 through #16 of http://caps.fool.com/Blogs/why-deficit-spending-and/621467 for a discussion.

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#51) On August 08, 2011 at 11:30 AM, JaysRage (89.80) wrote:

I have zero faith in our government to create jobs through their spending.  Obama laughed when his stimulus was criticized for not having enough job creation in it....that is was just pure spending.    We've had two stimuluses and both were horrible failures in terms of job creation.    Our government has proven that it is not efficient in creating jobs.    Since they have failed over and over again, I want the money to go in the hands of individuals and businesses to create jobs.   First, we have to starve the beast that is our government and stop letting them pretend that they can create jobs.   

We need Government spending, because private spending and demand is so bad right now and spending = income. But instead of just giving the citizens money directly, the only real solution is job creation. Jobs directly aimed a producing a more stable economic environment.

And while I think bailing out Main Street is better than bailing out Wall Street, bailing out is bailing out and encourages exceptionally bad behavior. Wall Street is back to all of the same tricks that led up to the crisis because they emerged unscathed!

Agreed.   The fact that no regulation got put forth, post-recession is appalling.  As mentioned above, all spending is not created equal.   Just giving people money floats the boat up until you stop giving them money.....then if floats back down.  No jobs created.   How many times to you want to float the boat up and down before real change is implemented?  

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#52) On August 13, 2011 at 11:56 AM, kirkydu (94.36) wrote:

@Jay

Austerity is what the U.S. foisted on emerging nations after we saddled them with debt that we had them take out on the promise of huge growth if they would just pay our companies to build their infrastruture of the future.

How about this, we cut tax loopholes & special interest tax breaks by $2T over a decade and use the money to rebuild our own infrastructure by paying our own companies and employing our own people.  The money stays at home, jobs created, natural monetary expansion (v Fed induced boat floating).

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