Stimulus or Austerity: Can Either Succeed?

by John Brian Shannon

In the age-old debate between stimulus and austerity, many commentators fail to realize both schools of thought could be correct — and in fact, both are.

For one, look at the uncountable billions of stimulus added to the American economy during President Reagan‘s two terms. Unprecedented billions were directed towards defense, R&D, infrastructure — and even to Chrysler — although, strictly speaking, those were loan guarantees.

Do loan guarantees count as stimulus? Almost. And those guarantees tied up billions of U.S. Government dollars until they were no longer required — and served to establish and add gravitas to a new momentum in the U.S. economy. Courtesy of President Reagan’s leadership, I hasten to add.

When we look at historic stimulus, it works. When the stimulus is added at the first sign of recession it is most effective. Once all those factories are shuttered, trying to add stimulus to improve the economy is an uphill battle, every day.

The Marshall Plan to rebuild Europe at the end of WWII is a classic stimulus success story. Anyone who visited 1945 Europe and then visited again in 1960 can attest to that! About $40 billion dollars were used to stimulate the European economy — a lot of money in those days, even by United States’ standards.

Think of stimulus spending as emergency funding to keep the economy functioning. It really only works when applied immediately and at the first sign of recession.

For two, austerity does work. Although, it must be said, removing obscene debt and irresponsible deficits from a large economy constitute a major structural change. It is no band-aid solution — although as I said above, band-aids do work.

Austerity fixes the underlying structural problem — while stimulus fixes the symptoms, if you will.

There is no doubt about the Baltic austerity success story and there are others. You need only look as far as Canada in the 1990’s. Canada’s credit rating was on the rocks, the economy was in the tank and economic vital signs were heading in the wrong direction.

Prime Minister Jean Chretien and his astute Finance Minister Paul Martin, decided to adopt aggressive Canadian-style austerity and it worked (short-term pain for long-term gain) better than anyone had imagined. It just took some political leadership, unusually good communications with voters and some serious brainstorming.

A final word on economist’s everywhere. European economists work for Europe’s well-being, Chinese economists work for China, er, directly! While American economists work to arrange things to America’s advantage — you can’t begrudge any side for ‘playing for the home team’.

If the New York Times, Nobel Prize winning economist Professor Paul Krugman believes that it is in America’s best interests to float the economy with stimulus money, then he is right. Of course while agreeing with him, I always point out that stimulus is a merely a temporary fix and that additional deficit-financing (and accumulated debt) should be ‘pared down’ during the boom times.

Just as John Maynard Keynes suggested.

When this is not done, decade after decade, or should I say, recession after recession, it adds to the unbalanced economy and the entire economic structure is thereby weakened.

For now, stimulus — although it is almost too late for band-aids. Then, during the next boom, adroit movement towards zero-deficit financing — then, once that is achieved, regular scheduled debt paydowns after that.

Stimulus will stop the worst of the present economic malaise from taking an even higher toll — and later, austerity will begin to improve the entire structure of the U.S. economy.

John Brian Shannon

The Canadian Austerity Success Story

The Canadian Austerity Success Story | 12/07/12
by John Brian Shannon John Brian Shannon

The Canadian success story on deficit elimination, debt reduction and significantly, strengthening the economy by adding jobs and improved economic performance during troubled economic times has been well-documented.

The Canadian icon known as MacLeans Magazine featured an outstanding piece by LEAH McLAREN in the October 10, 2011 edition entitled I told you so – which covered Prime Minister of the UK, David Cameron‘s speech to a joint session of the Canadian Parliament (both the Senate and the House of Commons) where PM David Cameron made a number of positive comments regarding Canada’s economic success.

Cameron commented:

“Canada got every major decision right” in the past few years of global market turmoil. He lauded the strength of both the Canadian banking system and our economic leaders, who, he said, “got to grips with its deficit” and were “running surpluses and paying down debt before the recession, fixing the roof while the sun was shining.”

Cameron’s admiration for Canada’s relatively peachy fiscal position stands in stark contrast to his dim view of his Eurozone neighbours. On the topic of Europe and the U.S. getting their own houses in order, Cameron said; “This is not a traditional, cyclical recession – it’s a debt crisis…”

He went on to say;

“When the fundamental problem of the level of debt and the fear of those levels, then the usual economic prescriptions cannot be applied.” – MacLean’s Magazine.

Read the entire article here…

MacLean’s is not the only publisher to write on this topic. Canada’s Globe & Mail have also published articles discussing the Canadian economic success story of the 1990’s and early 2000’s.

A seminal article by LOUISE EGAN and RANDALL PALMER ran in the Nov 21, 2011 edition of the G&M entitled The lesson from Canada on cutting deficits — a short excerpt of which appears below. Please take the time to read and save the entire article.

“Finance officials bit their nails and nervously watched the clock. There were 30 minutes left in a bond auction aimed at funding the deficit and there was not a single bid.

Sounds like today’s Italy or Greece?

No, this was Canada in 1994.

Bids eventually came in, but that close call, along with downgrades and The Wall Street Journal calling Canada “an honorary member of the Third World,” helped the nation’s people and politicians understand how scary its budget problem was.

“There would have been a day when we would have been the Greece of today,” recalled then prime minister Jean Chrétien, a Liberal who ended up chopping cherished social programs in one of the most dramatic fiscal turnarounds ever.

“I knew we were in a bind and we had to do something,” Mr. Chrétien, 77, told Reuters in a rare interview.

Canada’s shift from pariah to fiscal darling provides lessons for Washington as lawmakers find few easy answers to the huge U.S. deficit and debt burden, and for European countries staggering under their own massive budget problems.

“Everyone wants to know how we did it,” said political economist Brian Lee Crowley, head of the Ottawa-based think tank, Macdonald-Laurier Institute, who has examined the lessons of the 1990’s.

But to win its budget wars, Canada first had to realize how dire its situation was and then dramatically shrink the size of government rather than just limit the pace of spending growth.

It would eventually oversee the biggest reduction in Canadian government spending since demobilization after the Second World War. The big cuts, and relatively small tax increases, brought a budget surplus within four years.

Canadian debt shrank to 29 per cent of gross domestic product in 2008-09 from a peak of 68 per cent in 1995-96, and the budget was in the black for 11 consecutive years until the 2008-09 recession.

For Canada, the vicious debt circle turned into a virtuous cycle that rescued a currency that had been dubbed the “northern peso.” Canada went from having the second worst fiscal position in the Group of Seven industrialized countries, behind only Italy, to easily the best.

It is far from a coincidence that the recent recession was shorter and shallower in Canada than in the United States. Indeed, by January, Canada had recovered all the jobs lost in the downturn, while the U.S. has hardly been able to dent its high unemployment.

“We used to thank God that Italy was there because we were the second worst in the G7,” said Scott Clark, associate deputy finance minister in the 1990’s.

Canada’s experience turned on its head the prevailing wisdom that spending promises were the easiest way to win elections. Politicians of all kinds and at all levels of government learned that austerity could win.”  read more…

For those unfamiliar with examples of successful austerity, Canada holds great promise. There are others to discuss in the coming days – which will illustrate austerity can actually lessen the unfavourable effects of decades of excessive spending by governments and improve the economic position of a nation.

The Case For Austerity

by John Brian Shannon

Finally, finally, finally.

After decades of running endless deficits which, when left unpaid at the end of each year are added to the government debt — increasing the overall debt-to-GDP ratio numbers of nations, many governments around the world have begun to rein-in their spending.

Why is that important? Because those are the same debt-to-GDP ratios that the worlds major credit rating agencies cite when they lower the credit rating of nations which have managed to spend more than they take in year after year – through the good times and the bad times.

Decade after decade, deficits pile up, until one day your national credit rating has sunk from AAA+ to only B+ or worse! This brings about a number of unwanted consequences for those countries.

One, the cost of borrowing multi-billions of dollars to cover government debt is increased at each and every downgrade.

A small change to the interest rate doesn’t hurt much when the amount financed is a small amount, but it really hurts when the amount financed is in the hundreds of billions of dollars. For example, the U.S. is presently financing 15 Trillion dollars of debt (accumulated deficits) and will add another 1.4 Trillion dollars of deficit to the government debt at the end of this fiscal year – September of 2012.

Imagine the borrowing costs on 16.4 Trillion dollars. Now, imagine the borrowing costs on 16.4 Trillion dollars and add another 1% to that interest rate – which is the hypothetical equivalent of a one-point reduction in the credit rating, let’s say from AAA to AA for example. Forget about the B+ rating – you don’t want to know.

Year in and year out, in good times and in bad times, huge chunks of national treasure in the form of interest payments on federal debt and deficits are paid by the taxpayers to foreign lenders to cover the cost of government overspending. It is an automatic drain on a country’s wealth.

Credit rating agencies become empowered at times like these and begin making suggestions to governments in order for them to receive a better credit rating – and thereby lower their overall cost of borrowing.

One suggestion is to impose austerity measures to lower government spending – in an attempt to stem the economic bleeding of the economy in question.

Cutting the number of government workers to decrease government spending is one way to accomplish that – as is reducing the number, or quality, of services that a government performs. In fact, there are thousands of ways to raise revenue and lower spending to eventually produce a zero deficit condition. Levelization of government finances becomes the priority.

Which is a relatively easy thing to do during the good times when the economy is expanding, jobs are plentiful and the government is raking in boatloads of income tax, sales tax and other government revenue-generating schemes — although, even then it is rarely attempted.

Some excellent examples of exceptions to this paradigm do exist.

Austerity during the bad times has no redeeming value at all – except for one important point, which I will cover shortly.

Politicians have traditionally shunned austerity during the good times because in all but a very few cases it gets them voted out of office.

At the worst possible moment, we are now beginning to do the right thing — returning to balanced budgets and paying down government debt.

Everyone is beginning to ‘get it’ governments simply cannot run huge deficits decade after decade and not face a downgrade of their credit rating, which drives up the cost of financing that accumulated debt load. Which, in turn, slows the economy – code words for increased unemployment, higher taxation, stagflation and a lowering of services provided by the government.

So, what is the important point? Voter acceptance – which may be putting it too strongly – but at the very least an understanding is now forming in the consciousness of voters, that governments cannot continue spending at unsustainable levels for decades at a time. Tentatively at first, but now with increasing resolve, politicians have begun to feel empowered to speak out about lowering government deficits and cutting national debt loads.

Now that the process has started (very unfortunately, during the bad times) I would expect it to continue during the coming good times – which, according to the legendary words of economist John Maynard Keynes – is the proper time for deficit-cutting and debt paydown.

It has worked before. In the early 1990’s, Canada was facing high deficits, a toxic government debt load and a lowering of it’s credit rating — at a bad time economically speaking. The then-government of Prime Minister Jean Chretien and his astute Minister of Finance Paul Martin, jumped at the opportunity during a time of nominal growth and higher taxation to cut the deficit to zero and dramatically paydown the accumulated Canadian federal debt.

In short, a win for austerity. A wildly successful effort by those two gentlemen who made it look easy and who never, ever, once complained once about the task fate appointed them.

In fact, there is no doubt at all about it in Canada – austerity won and it won handily.

In the case of Canada, there was no option but to win, there were no better choices available and no big brother like some nations in the EU have available to them to bail us out. The government of the day decided to pare down spending, increase revenues and they were so successful at doing so their plan worked better than even they themselves had envisioned.

The reason Canada was so successful?

Theirs was anything but a clumsy attempt to balance the budget and paydown the debt and both the Prime Minister and the Finance Minister went around to meet the Premiers of each Canadian Province to sell the austerity package to Canada’s Premiers before attempting to take their plan further afield.

Then, and only then, they went to Wall Street to sell the world’s leading economy on the Canadian plan to eliminate Canadian deficits and lower the country’s total debt load.

Once all of that had successfully taken place, Canada’s Prime Minister and its Minister of Finance approached the credit rating agencies with a fait-accompli plan.

By ensuring the full support of every relevant player well-beforehand, Canada won over the credit rating agencies in a moment.

John Brian Shannon writes about green energy, sustainable development and economics from British Columbia, Canada. His articles appear in the Arabian Gazette, EcoPoint Asia, EnergyBoom, Huffington Post, the United Nations Development Programme – and other quality publications.

John believes it is important to assist all levels of government and the business community to find sustainable ways forward for industry and consumers.

Check out his personal blog at: http://johnbrianshannon.com

Check out his economics blog at: https://jbsnews.wordpress.com

Follow John on Twitter: https://www.twitter.com/#!/JBSCanada

SEE ALSO:

http://www.theglobeandmail.com/report-on-business/economy/the-lesson-from-canada-on-cutting-deficits/article4252006/?page=all

A short excerpt of this excellent article appears below. Please click on the link above to read the entire article.

The lesson from Canada on cutting deficits
LOUISE EGAN, RANDALL PALMER
OTTAWA— Reuters
Published Monday, Nov. 21, 2011 2:32 PM EST

“Finance officials bit their nails and nervously watched the clock. There were 30 minutes left in a bond auction aimed at funding the deficit and there was not a single bid.

Sounds like today’s Italy or Greece?

No, this was Canada in 1994.

Bids eventually came in, but that close call, along with downgrades and The Wall Street Journal calling Canada “an honorary member of the Third World,” helped the nation’s people and politicians understand how scary its budget problem was.

“There would have been a day when we would have been the Greece of today,” recalled then prime minister Jean Chrétien, a Liberal who ended up chopping cherished social programs in one of the most dramatic fiscal turnarounds ever.

“I knew we were in a bind and we had to do something,” Mr. Chrétien, 77, told Reuters in a rare interview.

Canada’s shift from pariah to fiscal darling provides lessons for Washington as lawmakers find few easy answers to the huge U.S. deficit and debt burden, and for European countries staggering under their own massive budget problems.

“Everyone wants to know how we did it,” said political economist Brian Lee Crowley, head of the Ottawa-based think tank, Macdonald-Laurier Institute, who has examined the lessons of the 1990s.

But to win its budget wars, Canada first had to realize how dire its situation was and then dramatically shrink the size of government rather than just limit the pace of spending growth.

It would eventually oversee the biggest reduction in Canadian government spending since demobilization after the Second World War. The big cuts, and relatively small tax increases, brought a budget surplus within four years.

Canadian debt shrank to 29 per cent of gross domestic product in 2008-09 from a peak of 68 per cent in 1995-96, and the budget was in the black for 11 consecutive years until the 2008-09 recession.

For Canada, the vicious debt circle turned into a virtuous cycle that rescued a currency that had been dubbed the “northern peso.” Canada went from having the second worst fiscal position in the Group of Seven industrialized countries, behind only Italy, to easily the best.

It is far from a coincidence that the recent recession was shorter and shallower in Canada than in the United States. Indeed, by January, Canada had recovered all the jobs lost in the downturn, while the U.S. has hardly been able to dent its high unemployment.

“We used to thank God that Italy was there because we were the second worst in the G7,” said Scott Clark, associate deputy finance minister in the 1990s.

Canada’s experience turned on its head the prevailing wisdom that spending promises were the easiest way to win elections. Politicians of all kinds and at all levels of government learned that austerity could win.”  read more…

 

 

 

 

Why Are We In Debt? – MY COMMENT

by John Brian Shannon

As far as economist’s go, you can’t have enough respect for Professor Paul Krugman. Passionate about his calling, vociferous in his critique of failed fiscal or monetary policy and as fine a gentleman as you could ever hope to meet.

He is so compelling and believes in his mission so deeply that even his fiercest economic critics find themselves nodding in agreement with him – before they snap out of it and return to the party line they were following prior to the beginning of the good Professor’s speech.

He is arguably the leading economist on the planet – and I doubt he would have a problem with me putting his life’s work into those terms as he himself realizes that he is in some pretty fine company.

So why would I, wearing my junior economist hat, ever disagree with him on any matter of economics? Just who do I think I am?

Well, I have found a clearer version of my usual answer and it was the kind Doctor of Economics himself, who provided it to me in one of his recent articles.

To read his article, please visit: The New York Review of Books

How to End This Depression
by: Paul Krugman
http://www.nybooks.com/articles/archives/2012/may/24/how-end-depression/

In case you just got back from Mars, Krugman is famously anti-austerity, regularly informs us of the ills of the American economy and posits remedies for present fiscal and monetary maladies. I should say right now that he is most often right. Depending which year it is, that is usually 364 out of, oh well, 365 days of the year. Just saying.

So, three paragraphs into his fine article, we read this:
“But don’t we have to worry about long-run budget deficits? Keynes wrote that “the boom, not the slump, is the time for austerity.” Now, as I argue in my forthcoming book*—and show later in the data discussed in this article—is the time for the government to spend more until the private sector is ready to carry the economy forward again. At that point, the US would be in a far better position to deal with deficits, entitlements, and the costs of financing them.”

Imagine me nodding my head in full agreement with Professor Paul Krugman! Me – a fervent austerity-booster! Imagine that. Didn’t I tell you that was going to happen? Yes I did.

He does have that effect on economist’s all over the world – including those who disagree with his views on the austerity question.

I too, am a Keynesian and I agree profoundly with those words spoken by John Maynard Keynes so long ago and I’ll prove it now.

Ricardian Equivalence aside, lagging economies do need stimulus! The time for the government to begin spending money to boost the economy is in the first few seconds after an official recession has been called by the market. That’s three consecutive quarters of zero growth or decline, or a mixture of both, followed by an official announcement in order to qualify for recession status.

Irregular government stimulus has been happening since before the stock market crash of 1929 when government intervention began in earnest the American marketplace as a force against market turmoil.

Let me say it as plainly as I can, John Maynard Keynes and Paul Krugman are absolutely right, stimulus has been proven to work, it begins to work immediately and it does fulfill the desired effect. It works every time.

The fact that Ricardian Equivalence kicks in part way through the process to begin the incremental process of diminishing the government stimulus – doesn’t change a thing. The stimulus does exactly what it is supposed to do and the fact that consumers later adjust their savings and spending, resulting in a flat net gain to the economy a decade or two later matters little – because all of that takes place on a completely different schedule compared to the instant economic gratification stimulus spending plan.

To put it plainly, the full effects of Ricardian Equivalence take 10-20 years – and if the stimulus hasn’t recovered the economy before Ricardian Equivalence kicks in, you have way bigger problems than three quarters of net loss in the market!

Spending our way out of recession by virtue of taxpayer-supported government stimulus is the equivalent of knowing well-in-advance the exact future day that your house will burn down — and going to the bank as soon as you find this out, in order to borrow sufficient funds to buy the property next door and build your new house identical to the old house — and having it completed and ready to move into, just hours before your old house burns down.

You are no further ahead in absolute terms – but you have an exact duplicate house and property and the exact same mortgage and you don’t have to sleep in a hotel for six months waiting for your new house to be built. Saving you significant misery – which is the whole point of government stimulus, saving millions of citizens from significant misery in the 0 – 10 year time-frame.

This is the secret of government stimulus spending. The government can spend as much stimulus money as it wants. If government stimulus is large and the spending commences soon after the announcement of recession, the economy begins improving almost immediately.

If it spends the stimulus money too slowly, over a ten year period for example, the effect is greatly minimized and could end up a complete failure in every sense. The law of diminishing returns is what happens when government begins a large slow-motion spending program designed to stimulate the economy.

But when it begins immediately and is targeted to produce the best results, it is the exact medicine a country needs – even if, sometime past the ten-year mark, the national economy is no further ahead in absolute terms on account of that stimulus.

Why is stimulus important? Because it immediately and dramatically begins to lower the misery felt by millions of citizens who suddenly become unemployed during recessions. In fact, government stimulus spending creates jobs and can prevent further job cuts as the market sees the strength of the economy and the level of government commitment to the economy. Many a recession has turned out to be a paper recession because a government took early action, spent much – and pushed the evil day farther down the road.

We’re here at the evil day. And if not now, certainly by the next recession – which used to be farther down the road, but is now close to where we live these days.

Keynes wrote that “the boom, not the slump, is the time for austerity.”  – That is very true.

As Professor Krugman wrote in his article which I quoted above:

“Now, as I argue in my forthcoming book… is the time for the government to spend more until the private sector is ready to carry the economy forward again. At that point, the US would be in a far better position to deal with deficits, entitlements, and the costs of financing them.”

Which decade after decade, continues to not happen. Many multi-billions have been spent on government stimulus but none, not one, of those borrowed multi-billions have ever been paid back. Deficit after deficit has accumulated since before there were rocks, and now the debt is piled so high we might not have the chops with our lenders to borrow stimulus multi-billions so that we may assist those who are in unemployment misery – or worse.

The simple fact is, governments can borrow as much as they like and not pay it back – ever! And they have. But eventually, a day will arrive when nobody will lend us more money. Whether this is the case now, or whether it waits till the next recession, we are at or near the end of this particular paradigm of borrow, stimulate and not pay it back during the boom times.

We can’t blame the economist’s – their job is to help the economy progress, to create wealth, to lure capital, to innovate new ways of using money for the good of the nation – and so much more. But economist’s do not have secret powers to force governments to “pay off deficits and pay down debt when times are good” as John Maynard Keynes many times suggested.

We can’t blame the Russian’s anymore – this wasn’t their fault.

We can’t blame our politician’s – because any politician who brings up the topic for even a nanosecond – simply does not get elected!

We want our nice life now, we want our tax breaks now, we want our government spending programs now, we want our toys now, and we don’t want to hear about paying for them.

Why are we in debt? Because that’s what we have asked for every year since before there were rocks.

If we want to continue as a solvent and sovereign nation, we need to authorize a President and a Congress (at the same time!) to print enough money to cover next year’s deficit, effectively clearing our current account to zero. We need to pass legislation that will eventually outlaw deficit spending – except during times of national emergency. We need to pass laws that will force the government to pay down the accumulated government debt by 2% per year until it reaches a sustainable level, say debt-to-GDP ratio of 50%, or less. And we need to start living within our means as a civilization.

Other nations cannot be expected to take the lead on this and until the U.S. begins to do so, western countries will remain uncomfortably near the end of this present paradigm, living uncomfortably close to economic disintegration.

An economic netherworld beckons.

Follow John Brian Shannon on Twitter: https://twitter.com/@JBSCanada

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Related articles

Greek and French Voters Overturn Austerity

By John Brian Shannon

Greek and French voters have overturned austerity in Europe, but voters have really overturned a change to sustainable economic policies.

The structural changes there have caused some level of financial problems for individuals and families.

But the alternative was to let the outrageous, drunken-sailor spending continue until there was nothing left of the economies in question. Eventually that would have caused a real pan-European depression  – instead of five years of austerity in only those countries foolish enough to have overspent themselves for decades.

It is the obscene deficits which have run year after year (and have piled up into unaffordable debt) that are responsible for the lowered credit ratings in those countries and the poor economic performances found only in those particular European countries, it must be said. I note that the rest of Europe is doing quite well – even accounting for the combined drag and multi-billion euro bailouts of Greece, Portugal and Spain.

Blaming austerity, is like blaming the doctor who is now fixing your broken arm for the original accident — as you drunkenly stumbled out of the casino! The Greek economy was a basket-case long before austerity ever arrived and it will be a basket-case now that austerity is leaving Greece.

Greek and French citizens have voted for the former glory days of unrestrained spending with lots of toys and goodies from their governments – and to hell with paying for it!

“Let the EU bail us out forever, for tonight, we drink like drunken sailors!” And, if you think that isn’t being hollered at full volume at many thousands of cantina’s and spilling out on to the streets of Greece tonight, you’ve never been there!

Follow John Brian Shannon on Twitter: https://twitter.com/@JBSCanada