The Bizarro Economics of Government Spending

Good news and bad news. But which is which? The situation is so confused, we can’t tell.

The good news is that housing prices are going down. That’s what The Wall Street Journal says. “Home prices declined in November.” Good. People will be able to find more affordable housing.

Wait. That’s not good news, is it? Doesn’t that mean we’re still in a depression? Besides, another report says housing is going up. What to believe?

Let’s try something else… Consumer confidence rose in the latest reporting period. No argument there…

Now, that’s definitely good news, right? Nope. The better things get the more likely the feds are to clamp down on the recovery by “exiting” their stimulus efforts and reducing the deficit. That’s part of the reason stocks often decline when the news is “good” and go up when it is “bad.” Investors are afraid the feds will take away the juice. That would risk a return of the “error of ’37,”…say economists such as Paul Krugman and Richard Koo. Ignoring the calendar a bit…it would turn our president into “Herbert Hoover” Obama, as one commentator suggested.

What happened in the ’30s? Well, in the approved storyline, the feds had their stimulus foot to the floorboards…and they were happily driving right out of the depression. But fearing inflation…deficits…and a backlash against excessive spending (and believing that they were clear of the bad neighborhood) – they slowed down…they eased off their stimulus efforts in the mid-’30s. This sent the economy into another downturn and stretched the depression out for another 3 years.

It’s nonsense. What really caused the relapse of ’37 was the feds’ own meddling. But that’s not the way mainstream economists and analysts look at it. In their cockamamie view, an economy grows thanks to the good stewardship of publicly elected officials. In their view, government spending is actually BETTER than private spending. Why? Because it produces nothing of value. Really; we’re not making this up. And so what if the government doesn’t have any money? To them, money that doesn’t exist – created ‘out of thin air,’ as Keynes put it – is BETTER than real money. Because it creates consumer price inflation. Up is down. Good is bad. Better is worse. In their view, what makes a strong economy is government action. Specifically, government spending. So, anything that might incline the feds to spend less is BAD news.

According to the papers, there’s some bad news coming. ’Cause Mr. President is going to tell the nation in his State of the Union address that it’s time to put on the brakes. If we don’t, people will get the impression that government spending is out of control. We can’t have that. Because lenders might refuse to lend. Investors might refuse to invest. Voters might refuse to vote for the scalawags now in office.

On the other hand, if the Prez really does cut spending, none of the aforementioned are likely to be very happy about it. Federal spending doesn’t really make people richer; it makes them poorer. Still, appearances are what really matter. Dim economists want a president who puts into action their loopy theories. And dim voters want a president who takes action to save them from their own mistakes…especially when it means getting their hands on someone else’s money.

The stimulus offered by government spending is phony. But it appears real to the masses. Take it away and the economic consequences will appear very real too. The ‘creative destruction’ of the market will finally get to express itself. Businesses that should fail will fail. Speculators who ought to lose money will lose money. There will be blood, in other words.

Like most people, we don’t mind a little blood…as long as it’s not our own. So you can imagine how the parasites will howl when they see the knife draw near to their own arteries!

They can relax. The feds are not likely to reduce spending significantly. The deficits are structural…they’re built-in to the system…they won’t go away.

And as the depression lingers, the debt piles up…

What will happen? We don’t know. We can’t look into the future. But we can look at Japan…a country that is at least 10 years ahead of us.

Why is Japan ten years ahead? Because its stock market turned down in 1989…a decade ahead of Wall Street. And because its population is about 10 years older. And because it’s been fighting the de-leveraging process for 20 years. What can we learn? Here’s the latest from the WSJ, warning of an explosion:

“S&P lowers Japan’s outlook to negative.”

Uh oh. Not too encouraging. The rating agency told Japan that if it didn’t cut its deficits its debts would be downgraded.

Ah yes… Thanks to the Japanese, we get to see someone cross the minefield ahead of us. After 20 years, Japan hasn’t been able to get clear. But it hasn’t blown up completely, either.

But watch closely. It’s putting its feet down on some dangerous ground. Deficits have grown and grown and grown. Now, it risks an explosion with every step. This year, it will borrow $480 billion. It will receive only $405 billion in tax revenue. As far as we know, no major economy has ever run so far into the red without a blow-up.

And what can it do? They are getting the same sort of advice as Obama. They’re told they must cut the deficit to protect the currency…the economy…and the credit rating. But they’re also told that good is bad, or bad is good…that if they do the right thing – cutting the deficit – the economy will suffer. Tax revenues will fall further…widening the deficit!

The Japanese economy has become so dependent on debt-fueled government spending that, take it away and things fall apart. In the long run, that is exactly what should happen. The economy needs a shake-up…so it can rebuild on more solid foundations. But what politician wants to risk his own blood?

The Daily Reckoning