Post credit bubble fiscal austerity leads to depression

In the video at the end of this post I speak to RT Television about fiscal austerity in the UK and the likelihood of fiscal austerity in the US.

A few thoughts here:

Barack Obama says:

Government has to start living within its means, just like families do. We have to cut the spending we can’t afford so we can put the economy on sounder footing, and give our businesses the confidence they need to grow and create jobs.

Wrong on every single count. This is why the US is probably headed for a repeat of 1938. The President knows better, but he’s saying this stuff anyway. If you have the President spouting this nonsense, you know the Republicans will use it to force cuts that will weaken the economy.

The key here is that it does no good for the Republicans politically to compromise with President Obama. His policies are rightfully seen as failed. The right thing to do politically (but not morally) is to try and strike as much contrast to the President as you can, especially if it makes him look more failed. So that means favouring gridlock and pushing deficit reduction, looking for spending cuts and so on – even if it leads to a government shutdown stare-down as it did under Clinton. Is this the right thing to do?  I don’t think so, if only because it reduces the number of potential positive economic outcomes. But I am speaking now more from a forecasting perspective than one of advocacy.

A few comments about Tuesday’s election’s impact on the economy, Nov 2010

The cuts are coming. The President has assured as much through his misguided rhetoric. We’ll just have to see whether the economy in the US is weak enough that they cause a double dip.

On the UK:

the US has resisted austerity while the UK has embraced it. In my mind, this is the best real-time economic experiment we can have on what does and doesn’t happen as a result of government spending.

The UK is noticeably weaker than the US.  They have failed. Expansionary fiscal consolidation is nonsense. It didn’t work in Ireland, Greece or Spain. And it won’t work in the US or the UK either.

Continuing where I left off from the previous quote, the problem is this:

Personally, I think the budget deficits in the U.S. are unsustainable [see here for why]…Nevertheless, I recognize that the large majority of the deficit in the U.S. has been driven by an output gap due to massive un- and under-employment.

My criticism of the Obama Administration has more to do with its lack of fight in creating jobs. And to the chagrin of my Keynesian readers, I am not talking about artificial boosts to aggregate demand. I don’t buy into the ‘aggregate demand is the only problem’ propaganda. The U.S. and the UK were on an unsustainable course with the FIRE sector (financial services, insurance, and real estate) sucking up an excessive amount of real resources that did not add to the longer-term capital formation. It certainly made a lot of people rich for a period of time. But for the societies as a whole, this misallocation of capital has been destructive, much more so than the telecom and technology misallocation which preceded the housing bubble.

If you want fiscal consolidation because you believe the government is propping up zombies in the FIRE economy, knowing that consolidation leads to economic weakness in the short –term, fine. That’s a risky strategy but it is one point of view. However, the concept that fiscal contraction boosts growth is voodoo economics and this what the governments in Britain and now the US are arguing.

My hope is that, despite slowing in Europe and China, the global economy will have enough pop to get the US through its experiment with expansionary fiscal contraction. But this is just a hope.

Video below.

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.