More Government Spending ... Problem or Solution? ... Austerity versus Stimulus

Let's tackle herein the the U.S. financial mess (inclusive of many cities and states), as well as its fundamental causes and potential solutions.

First, contrary to the popular belief of "progressives," the solution is not to be found in higher rates of taxation.

And second, despite the strongly held views of many "conservatives," the problem isn't our current level of debt.

But the problem is about government spending and why we accumulate mountains of government owed debt in the first place. If debt is incurred by individuals for private sector investment and not consumption, that's good. If it's taken on to support government "investment," that's bad.

It's the simple difference of how the borrowed funds are used and at whose direction. It's the difference between MOM and an investment in the future compared to OPM and protecting the present status quo.

Our problem is too little private sector led economic growth and investment. Accordingly, the solution will necessitate a serious approach to controlling wasteful government spending, and here's why.

Government spending is always offset, directly or indirectly, immediately or over time, by either (1) tax receipts, (2) government borrowing or (3) or debasing or weakening the currency by printing money.

Thus, focusing on solely on taxes misses the two wrongheaded government policies of taking on debt and weakening the currency relative to other currencies. All three maneuvers tend to produce a slower and more debilitated economy, and the fact that the cause is "hidden" by borrowing or printing more money instead of taxing is really not all that important. It all ends up at the same place.

Accordingly, the current debate about austerity or stimulus misses the point entirely.

The unhelpful debate over austerity vs. stimulus is subtitled 'For Europe, austerity isn't a choice; it's necessary:'

"The austerity-versus-stimulus debate has grown stale. It’s simplistic to argue that the U.S. is pursuing reckless fiscal and monetary expansion while Europe goes in the opposite direction, foolishly choosing austerity over growth.

In fact, the U.S. fiscal trajectory has turned contractionary with the budget deficit expected to fall to 5.5% of gross domestic product this year. That’s a big decline from the over 10% gap of 2009 when Washington spent 50% more than it took in. Tax increases and slower expenditure growth prompted the International Monetary Fund this week to mildly downgrade its U.S. growth forecast to below 2%. IMF chief Christine Lagarde has even worried that the budget cuts may be “too aggressive in the short term.”

In Europe, complaints persist that, like his predecessor, U.S. Treasury Secretary Jack Lew is hectoring the euro zone to abandon austerity in favor of stimulus. In fact, Lew’s main concern is that Europe’s double-dip recession will adversely impact the U.S. as the EU is America’s biggest trading partner.

During last week’s tour of euro-zone capitals, Lew took a milder, more nuanced approach than Tim Geithner had. From Berlin, Lew told NPR that he understood Europe’s need to get its fiscal house in order. “I don’t think they should back away from fiscal restraint. … The real question,” he said, “is the timing and the intensity as they’re recovering.”

Rather than being a policy choice, austerity is a consequence of failed policy. In a fixed currency zone like the euro, fiscal imbalances have to be corrected for the system to remain viable. For three years the euro has been ensnared in an existential crisis that gives no sign of resolution. German Chancellor Angela Merkel repeatedly warns that “if the euro fails, Europe fails, and we cannot allow that to happen.” Thus corrective action is taking place.

Harvard scholar and former European Central Bank board member Lorenzo Bini Smaghi has observed that “austerity is the result of countries’ democratic decisions to wait until the last minute before acting, under the pressure of the markets, mainly by raising taxes rather than implementing [long-needed] reforms.”

It was payments imbalances and fiscal deficits that caused the austerity and pain currently being experienced in Cyprus, Greece, Italy, Spain and Portugal. Absent currency devaluation, the choice is between leaving the euro zone and imposing austerity. . . .

Goldman Sachs economist Jim O’Neill is right to say that Europe has to find some way to grow or risk being left behind by America and fast-growing emerging markets, particularly China and Brazil. Regrettably, the major euro-zone countries are being forced to address their debt crises, and sluggish or no growth is likely to persist for some time.

By contrast, things go well here in the States. . . .

As Warren Buffett predicted a year ago, the U.S. economy is steadily and gradually improving. Car sales have reached a four-year high, the housing market has bottomed and is picking up, and equity prices have reached record or near-record levels.
 
The challenge for the U.S. is to put in place a medium- to long-term plan for deficit reduction of the sort recommended by Alan Simpson and Erskine Bowles. Unlike peripheral Europe, the United States has the advantage of its currency’s being the world’s principal monetary reserve. Markets are giving us precious time to correct a potentially disastrous and destabilizing financial imbalance. If the U.S. is to avoid future austerity, it needs a viable, bipartisan plan for putting its fiscal house in order."

Summing Up

The solution is simple. Unleash the private sector's ingenuity, ideas and innovation, all of which are based on risk and an unbounded faith in the uncertain future. That requires confidence and a government support system that doesn't thwart that confidence on the part of We the People.

Fixing our problems, including our nation's deficits and debts, is all a matter of timing, and timing is still on the side of the U.S. to fix our own problems.

Doing that, however, will require that we tackle in a straightforward manner such things as (1) encouraging rather than disparaging private sector growth initiatives, including energy independence, (2) dealing with our unaffordable entitlements programs over the long term and recognizing that generous guaranteed pension benefits for early public sector retirees aren't sustainable, and (3) recognizing that an emphasis on public sector productivity is essential.

Focusing on doing those three things will enable us to grow our way out of this financial mess, which we must do. There is no other realistic solution.

Otherwise, it's Europe here we come, and continuing the silly debate about the false choices of austerity or government stimulus will result in nothing good.

That's my take.

Thanks. Bob.