I talked some times earlier about the logics of a Keynesian stimulus, and from the fundamental signs spotted this week, this stimulus would appear, at least on the very short term, to have had some effect, thus fueling the further rise of the markets.
This week, the famous economist Joseph Stiglitz, an economist reputed for his works on the information asymmetry in the economy, and belonging to the Neo-Keynesian school, takes a stand on the US stimulus plan in an article published this week.
As an economist, he’s doing extremely well at pointing out the inefficiencies of the Obama policy in trying to create a Keynesian policy:
The Obama administration seems surprised and disappointed with the high and still rising number of jobless. It should not be. This was predictable. The true measure of the success of the stimulus is not the actual level of unemployment, but what unemployment would have been without the stimulus. The Obama administration was always clear that it would create some three million jobs more than what would otherwise be the case. The problem is that the shock to the economy from the financial crisis was so bad, even Barack Obama’s seemingly huge fiscal stimulus has not been enough.
But there is another problem: In the United States, only about a quarter of the almost $800-billion stimulus was designed to be spent this year. Getting it spent, even on “shovel ready†projects, has been slow going. Meanwhile, U.S. states are experiencing massive revenue shortfalls, exceeding $200-billion. Most face constitutional requirements to run balanced budgets, which means that such states are now either raising taxes or cutting expenditures – a negative stimulus that offsets at least some of the federal government’s positive stimulus.
In short, not only the “huge” amounts were not enough taking into account the impact of the crisis, but, in addition, the tax hikes by States to balance their budget have counterbalanced the easing the Federal deficit allowed.
In addition, Stiglitz points out a long-standing bone of contention between Republicans and Democrats: the use of tax cuts as a stimulus is considered as an inefficient tool in Keynesian economics. Tax cuts are known historically by economists to be mostly saved rather than spent.
At the same time, almost one-third of the stimulus was devoted to tax cuts, which Keynesian economics correctly predicted would be relatively ineffective. Households, burdened with debt while their retirement savings wither and job prospects remain dim, have spent only a fraction of the tax cuts.
Stiglitz also has a rather critical view of the banking bailouts: while consumers are too highly leveraged to start spending again in a “profligate way”, banks will not lend out in such a terrible economy (they will only play the money in the markets, but he does not address that side).
In the U.S. and elsewhere, much attention was focused on fixing the banking system. This may be necessary to restore robust growth, but it is not sufficient. Banks will not lend if the economy is in the doldrums, and U.S. households will be particularly reluctant to borrow – at least in the profligate ways before the crisis. The almighty American consumer was the engine of global growth, but that engine will most likely continue to sputter even after the banks are repaired. In the interim, some form of government stimulus will be required.
Stiglitz also addresses then those opponents of the stimulus plans. It is true that in the US the only word of taxation or government support or spending has a horrible sound to it. But in the economy, and as Stiglitz’s own works showed, the market always has some degree of inefficiency which call for some regulation.
In that respect, Stiglitz is much less worried about the size of the US debt, because, he says, some form of spending can be useful for future growth (“spending on assets”). He’s right in the sense that a State entering into debt to acquire economic assets (production tools, etc) can give the tools to the economy to recover more strongly. The issue being, he admits, that the banking bailouts amounted to little more than “Corporate Welfare”.
Some worry about America’s increasing national debt. But if a new stimulus is well designed, with much of the money spent on assets, the fiscal position and future growth can actually be made stronger.It is a mistake to look only at a country’s liabilities, and ignore its assets. Of course, that is an argument against badly designed bank bailouts, like the one in America, which has cost U.S. taxpayers hundreds of billions of dollars, much of it never to be recovered.
The national debt has increased, with no offsetting asset placed on the government’s balance sheet. But one should not confuse corporate welfare with a Keynesian stimulus. A few worry that this bout of government spending will result in inflation. The more immediate problem, however, remains deflation, given high unemployment and excess capacity. If the economy recovers more robustly than I anticipate, spending can be cancelled. Better yet, if much of the next round of stimulus is devoted to automatic stabilizers – such as compensating for the shortfall in state revenues – if the economy does recover, the spending will not occur. There is little downside risk.
Stiglitz does goes on to ask for a second round of Global spending to stimulate decisevely the economy:
The Obama administration erred in asking for too small a stimulus, especially after making political compromises that caused the stimulus to be less effective than it could have been. It made another mistake in designing a bank bailout that gave too much money, with too few restrictions, on too favourable terms to those who caused the economic mess in the first place – a policy that has dampened taxpayers’ appetite for more spending.
But that is politics. The economics is clear: The world needs all the advanced industrial countries to commit to another big round of real stimulus spending. This should be one of the central themes of the next G20 meeting in Pittsburgh next month.
The argument being made is typically Keynesian at heart. Spending by the State in periods of market inefficiency allows to recover the economy with minimum social damages (a point that tenants of a hard-line libertarian view often miss).
However, what Keynesian economists miss is that recoveries are often stimulated by innovation and increased efficiency in the economy. In that sense, the cost-cutting efforts made by many firms are making these very efficient tools for the upcoming recovery.
Signs of positive effects on the economy from State stimulus plans can be seen from production numbers in Germany and in China. I do expect to see at least some beginning of effect of the stimulus on the US industrial production numbers next week. Mainly because car production recovered in H1 thanks to the “cash for clunkers” program, and because an inventory reconstitution is taking place right now thanks to the low prices. Rail traffic has also recovered some.
People may point out that the consumer-pushed economy may fail to take over until a significant deleveraging takes place and they are probably right if it ever takes over again. However, this should not lead us to miss the bigger picture and the fact that an economy can perfectly recover with a high rate of joblessness. Economies can also change and the US can become a powerhouse of innovation or a new industrial powerhouse thanks to renewed savings efforts. New ways of functioning are generally found and it could very well be that for a prolonged period of time the US will be a country living mainly out of Government spending efforts.
When the deleveraging will come to hit home, mainly with the banks, then we may see a second backlash. And until the economy is back on the rails, the danger for any baby “black swan” to send the markets back rolling into oblivion is real. All the more as “inventory reconstitution” does not always translate into “economic recovery”.
But very short-term, on the fundamentals, the signals are positive, even if I would not be as affirmative for the rest of Q3 or Q4, considering the fall in the demand for commodities:
October-to-December forward freight agreements, or FFAs, for capesizes lost 4.7 percent to $36,750 a day, according to prices from Imarex ASA, a broker of the accords. That implies traders expect the market to drop 19 percent by year-end.
For traders, this is a difficult situation to be into. According to their time horizon, their perspectives will probably be different, many being probably bullish short-term (even as we approach insupportable levels of valuation), bearish medium-term and very cautiously bullish on the very long term.
The answer to such insecurity is probably doing what GS does best: hedging one way and the other according to your analysis. Some times, there are no simple answers to complex questions.
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