The Bear’s Lair: The world needs another Geddes Axe

The Geddes Axe, imposed in 1921-22 was a relatively successful attempt by Sir Eric Geddes to cut British public spending – it reduced military spending by 20%, for example. Shortly after World War I, the public’s urge to government economy was still strong enough to inspire an “Anti-Waste Campaign” to which Sir Eric’s efforts were a response – a similar even more successful effort was made in the U.S. in the Harding and Coolidge administrations. Sir Eric, where are you now that we need you?

Britain’s situation in 1921 would be familiar enough to us now but was very strange to a generation brought up on traditions of government thrift. The Prime Minister David Lloyd George, still with immense prestige through having presided over Britain’s victory in World War I, had three failings that are only too familiar today. First, he was a spendthrift in government, having discovered that throwing public money at a problem made him popular. Second, he had no understanding of or commitment to traditional economic principles, finding Maynard Keynes’ high-spending unorthodoxy very appealing. Third, he was a crook, selling peerages and other honors to the highest bidder, and being involved in several other highly unsavory transactions through his career. Since he was also a poor military strategist and a physical coward, with poisonous relations with all his top generals and a major role in the disastrous 1919 Treaty of Versailles, his high reputation, then and now, (he was ranked #2 after Churchill in a 2010 survey of Britain’s prime ministers) was wholly unwarranted.

Still, Britain’s budget remained well out of balance in 1921-22, much more so than it had been three years after the preceding major conflict, when Lord Liverpool and Nicholas Vansittart got it balanced by 1818, in spite of a much higher debt load (relative to GDP) than in 1921. Since the British electorate still valued thrift in government, and Lloyd George wanted to win the next election due within two years, Geddes was appointed by Lloyd George to make an enormous noise about cutting spending, ideally without actually cutting too much. The “Anti-Waste Campaign” produced the Geddes Axe, which much to Lloyd George’s annoyance actually made some significant cuts, stabilizing the British budget although not eliminating the deficit altogether. The British would have done better still by choosing President Coolidge (who halved U.S. Federal spending in six years) but alas he was unavailable to them.

Geddes’ modest success was due largely to the climate of public opinion, which retained a strong Gladstonian respect for economy in government. The Daily Mail under Lord Rothermere ran a strong “Anti-Waste Campaign” that built on this underlying feeling, without which it is unlikely that the Lloyd George government, composed of “hard-faced men who have done well out of the war” would have acted. Keynes’s spendthrift approach, already popularized in “The Economic Consequences of the Peace” was still at that date regarded as eccentric and out of the policy mainstream.

That encapsulates the problem today. In the United States, the last sign of public support for government economy occurred in the 1990s, with the brief balancing of the Federal budget. President George W. Bush, allegedly a Republican, abandoned that approach after 2000, both cutting taxes and wasting public money, driving the federal budget deficit above $400 billion even in an economic recovery. Since then Presidents Barack Obama and Donald Trump have abandoned any pretense of fiscal prudence, running the federal budget deficit into the trillions. In Britain, there was a very modest attempt at “austerity” under David Cameron – much needed, since the budget deficit had bloated to over 10% of GDP – but that too has now been abandoned and appears to be very unpopular. Ever larger deficits have been financed with central bank “funny money” policies, which bizarrely have not brought significant inflation.

To bring even a Geddes Axe level of public austerity, there must be public demand for it. That demand will not arise if, as at present, central banks print money to fund budget deficits without apparent adverse consequences. Each time monetary or fiscal policy deteriorates without anything adverse happening (at least, nothing that is apparent to the voting population) the credibility of sound money and sound-budget writers and economists deteriorates. If the damn wolf never appears, crying “Wolf” becomes an exercise in futility.

There are three possible “wolves” that could appear that might create a mass demand for government austerity. First, consumer price inflation might actually appear, at a rate of perhaps 10% that inconvenienced ordinary voters and caused them to demand change. I have written elsewhere that the government’s response to the coronavirus crisis makes this very likely. Whether you hold a monetary theory of inflation, a “too much money chasing too few goods” theory of inflation or a cost-push theory of inflation, it seems almost inevitable that the next eighteen months will see a substantial inflationary upsurge.

This therefore is the most likely trigger of a public demand for austerity; its main weakness is that it often takes several years for inflation’s true costs to become apparent. In the late 1960s and early 1970s, inflation began to climb above historic rates around 1965, and hit progressively higher peaks in 1969-70 and 1973-74, yet it was not until a third upsurge in 1978-79 that desirable fiscal and monetary policy changes became overwhelmingly in demand. If inflation stays mostly under 10%, therefore, and appears to subside after its upsurge, the calls for government austerity may remain confined to one side of the political aisle and may be overwhelmed by other factors.

The second possible trigger for a demand for government austerity is a seizure in the government debt markets. To the current generation this may seem vanishingly unlikely, but it was such a seizure in 1978-79 that caused President Jimmy Carter to appoint Paul Volcker Fed Chairman. In today’s markets, bond dealers probably rely on the “Fed put” by which the value of government bonds is underwritten by Fed money printing. However, a high percentage of U.S. Treasuries are today bought by the People’s Bank of China and other entities who may not be so confident that the Fed can always provide a floor on Treasuries’ value.

Should inflation appear, the Fed would probably feel duty bound to genuflect in the direction of tighter money. Even without that, however, the exceptional budget deficits being generated as a result of the Covid-19 epidemic, and the decline in U.S. productive capacity it is causing, may well cause long-term debt markets to seize up, which they will do suddenly and violently, as the stock market did last month. Should that happen, the Democrats in Congress will doubtless try to solve the problem and restore market confidence through a massive tax increase. That prospect, if nothing else, should restore in the U.S. public a long-lost demand for government austerity.

Should neither of these remedies work, we will have to wait for the U.S. Treasury to default on its debt. Based on past patterns, and the budget deficit as of February, this column has suggested that this could happen in about 2040, with the bankruptcy of the Social Security system in 2035 or so possibly pulling the date forward. (It seems almost certain that our masters will, when faced with a Social Security default that reduces pensions by 25-30%, attempt to put the gaping deficit on the tab, as they do everything else.)

The deficits caused by Covid-19, both in the budget and in the Social Security system through unemployment and reduced contributions, will undoubtedly accelerate this process. If the trainman does not apply the brakes at all, default on the Federal budget and bankruptcy of the Social Security system will probably occur almost simultaneously, in 2027 or 2028. Assuming those in charge of the U.S. economy see the ghastly end approaching by about 2025, and slow spending somewhat to avoid it, dual bankruptcy might be delayed until 2029, or at the latest 2030.

At that point fiscal austerity will be forced on the Feds by sheer lack of money. With the Social Security bankrupt and the Federal debt in default, the U.S. will no longer be able to borrow significant amounts of money and will consequently be forced to live within its means. Those means will themselves be vastly reduced by the economic depression which U.S. bankruptcy will undoubtedly cause.

The spending cuts to achieve this will make the Geddes Axe seem a mere razor blade nick. They will nevertheless be extremely salutary. Any politician proposing Keynesian remedies for anything will thereafter be laughed off the platform. Successful statesmen will doubtless revert to stiff wing-collars, like William Gladstone, to give an impression of rock-like resistance to excess spending. Corporations and individuals also will be forced to live within their means, as they will find it extremely difficult to borrow money. In terms of leverage, if in nothing else, we will revert to the standards of the post-Depression 1950s.

It all sounds utterly blissful — I can hardly wait. It is however a pity that the process of attaining this fiscal Nirvana will be so painful.

(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.)