Japan caused a euphoric rise in global stock markets last week by raising the cap on its “quantitative easing” purchases of government bonds to 80 trillion yen a year ($720 billion, some 14% of Japan’s GDP.) Yet even with the huge “stimulus” and the declining yen to which it has led, Japan can still barely get its GDP growth rate up to 1%, while its budget deficit is some 8% of GDP. Other countries have tried similar approaches to stimulating their economy and have similar problems. Keynesian public spending stimulus, touted recently by the IMF as the solution to the problem of global economic sluggishness, isn’t working. It’s worth pondering why not.
Before 1929, politicians and economists were united in thinking it madness to undertake unfunded public spending without good reason. Both main parties in Britain and the United States were agreed on this. In the United States, the Republicans were in favor of infrastructure spending, having begun their career in office by starting a major civil war and simultaneously using public land grants to finance the transcontinental railroad. The Republicans were also in favor of high tariffs, among other nostrums of which economists then and now would disapprove, but they certainly never voluntarily undertook deficit spending. When William McKinley became President in 1896 and inherited a major recession and federal budget deficit from Grover Cleveland he devoted every attention to balancing the budget, which he achieved by the end of his first term in 1900 in spite of fighting the Spanish-American War.
Meanwhile the Democrats were the party of small budgets, objecting to the Republican penchant for public works and seeking to cut spending in order to be able to lower tariffs; Grover Cleveland himself has since become a hero to a modern small-government advocate, James Grant of Grant’s Interest Rate Observer; he would have regarded modern Democrats as William Jennings Bryan populists run mad.
In Britain, William Gladstone spent his career as Chancellor of the Exchequer and Prime Minister, over a period of forty years, in advocating for government retrenchment and low taxes. On the Tory side, Lord Liverpool was the founding father of nineteenth century sound finance, while his Conservative party successors Peel, Derby, Disraeli and Salisbury, while deviating from his principles in many respects, followed him on this one.
In the first quarter of the twentieth century, governments in both Britain and the United States expanded their reach, with Britain instituting a system of old age pensions and national insurance, while the United States nationalized the monetary system through the creation of the Federal Reserve. Yet even the architects of Woodrow Wilson’s New Freedom or David Lloyd George’s Land Fit for Heroes to Live In did not contemplate running budget deficits to achieve their goals (Lloyd George became a Keynesian only after he left office.) Thus both groups stirred up class hatred against the rich in an effort to finance higher public spending through higher taxes on the plutocracy.
There is no question that by 1929 the left wanted to spend more public money, and were only inhibited by the public distaste for high taxes imposed beyond the plutocracy. Hence Maynard Keynes’ theories came as manna from heaven. The New Deal, with its associated deficits, was the first experiment in Keynesian economics – in Keynes’ home country the great Chancellor of the Exchequer and then Prime Minister Neville Chamberlain regarded Keynes as a charlatan, kept him firmly segregated from the levers of power and from inside information and as a consequence wrecked his hitherto stellar insider-trading-driven investment record. Chamberlain also produced a very impressive economic recovery amidst global depression.
Keynesian stimulus spending doesn’t work. The New Deal prolonged the Great Depression by several years, causing a second downturn in 1937-8, which lifted only when the Republican/ Southern Democrat victory in the 1938 midterm elections stopped the New Dealers in their tracks.
But that fact was obscured by another Keynesian artifact: GDP accounting.
Devised in 1934 by the Keynesian economist Simon Kuznets, the GDP statistic takes all government spending as worth 100% of its value in output, no matter how misguided or futile the item concerned. In an extreme case, an economy that produced absolutely nothing, but where the government paid everybody substantial wages to dig holes and fill them up would be recorded as having a large GDP – until credit markets stopped financing the deficit-crazy government. If the government had a Bernankeist central bank attached, printing money to finance the government’s “transfer payments,” then until the currency collapsed on the foreign exchange markets, the unproductive scam could be kept going forever.
This ultimate frontier of Keynesian “stimulus” fiscal policy combined with Bernankeist “stimulus” monetary policy, all validated by Kuznets’ dodgy accounting, is where we have been for the last six years. Little wonder that the current recovery feels unsatisfying; to a degree hitherto unprecedented it consists of unproductive government spending financed with unsound Fed stimulus, and all reflected in the phony books at full value. The $500 billion or so in annual U.S. deficit spending – a level laughably described as “austerity” by those wishing to push it up even further – contributes very little to economic growth, which is hence stuck at a level that fails to absorb the available labor, while reducing productivity in the sectors struggling against excessive regulation.
Keynes’ objection to Say’s Law, which states that supply creates its own demand, is validated by a Keynesian policy that provides artificial demand without any attempt to secure a supply sufficient to cover it. Like most economic laws, it is valid in a state where other factors are not distorted, but can go wrong when massive economic distortions are introduced.
Much practical modern economics consists of finding second-best solutions to situations in which benign economic laws that are both self-evident and true cease to operate because some damn-fool government has removed the conditions that make them valid. The most obvious example of this comes from governments replacing a clear monetary rule such as the gold standard (or a constant money-supply-growth mechanism) with money created at the whim of a social engineering Fed. There are however many others.
Keynesian spending “stimulus” is the universal panacea, proposed by the IMF and almost the whole corpus of officially employed economists for every supposed failure of national or indeed global economies to behave as they should. Far from being effective, it distorts the economies further, diverting yet more resources into unproductive government projects rather than deploying them effectively through the private sector. The United States recovery has been affected by this, and is only as healthy as it is because of the immense good fortune of new fracking techniques applied to the country’s immense oil and gas deposits – a development that is resisted by statist politicians whenever they feel strong enough to do so.
As for Japan, the Keynesian approach has now been tried consistently since 1995, with only a short partial break during the premiership of Junichiro Koizumi (2001-06). It has completely failed to bring solid growth, and has distorted capital allocation further by flooding the market with cheap government debt. Over the past 20 years, government debt has been a more profitable investment in Japan than publicly quoted stocks, a staggering condemnation of government policy which fully explains the economy’s failure to grow.
Needless to say this will shortly change; with government debt now 240% of GDP and Japan’s budget deficit at 8% of GDP, the highest in the civilized world and showing no evidence of being reduced, the end cannot be far off. The new additional stimulus proposed by Bank of Japan Governor Haruhiko Kuroda will not postpone the inevitable crash, it will hasten it.
The Keynesians meanwhile, far from praising the efforts of Germany and other EU countries that have kept their budgets in balance or close to it, instead plead for more “stimulus” spending in the hope that Germany can become as profligate as France, Italy or even Greece. Surely it must be obvious that far from reviving the appallingly sluggish eurozone GDP, expected to grow only 0.8% in 2014, the recalcitrance of French budget officials in particular is leading the Eurozone further from stability and growth. When the non-German Eurozone is running a budget deficit of some 4% of GDP in the sixth year of nominal economic recovery, the “fiscal stimulus” pedal is being pressed very hard indeed. As in Japan, it clearly isn’t working.
The reality is that the world economy isn’t working properly because ham-handed governments all over the world have introduced distortions of excess spending, excess money creation and excess regulation that have put sand in the gears of what would otherwise be a normal economic recovery. Fairly shortly, either a fiscal crash or a malinvestment stock market and real estate crash or both will cause the wheels to come spectacularly off the world economy. My guess is that this will occur before the 2016 U.S. elections, making the debate there especially salient for the world’s economic future. For the sake of us all, I hope the questions get answered the right way this time.
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)