23 July 2009

Getting it very wrong on debt

On some previous occasions in this blog I have referred positively to Ambrose Evans-Pritchard of the Daily Telegraph as a rare journalist with half a clue about what is actually going on in financial markets. This is because his tendency to say that the financial crisis is much worse even than it appears now chimes in with my gut instincts about what is going on at the moment.

However, in his latest article "Fiscal ruin of the Western world beckons", Evans-Pritchard has delivered a real turkey, showing a worrying low understanding of basic macroeconomics.

It's clear that something is very wrong from the start of this article. I quote:

For a glimpse of what awaits Britain, Europe, and America as budget deficits spiral to war-time levels, look at what is happening to the Irish welfare state.

Events have already forced Premier Brian Cowen to carry out the harshest assault yet seen on the public services of a modern Western state. He has passed two emergency budgets to stop the deficit soaring to 15pc of GDP. They have not been enough. The expert An Bord Snip report said last week that Dublin must cut deeper, or risk a disastrous debt compound trap.

This illustrates the fallacy of the conventional IMF approach to macroeconomics. As long as public spending and services are cut enough, the deficit will be eliminated and then everything will be OK.

Whereas in fact, in the current economic situation, the deficit is the key thing keeping the Irish economy from being in an even worse state. The emergency budgets have depressed demand for goods and services, depressing tax receipts and making the deficit wider - leading to calls for another emergency budget. And so on, presumably until the last Irish civil servant has left the building, and the country is in a state of anarchy.

Ireland is of course in more of a bind than the UK for two reasons: (1) it took a larger economic hit from the credit crunch (and hence has a bigger deficit as a proportion of GDP) and (2) it's in the Euro so it can't set its own interest rates and can't use quantitative easing to stimulate the economy (although as previously noted in this blog, it is still far from clear whether QE actually works or not).

Rather than engaging in an endless cycle economic self-harm to satisfy the IMF and footloose international capital, Ireland's best way out of the crisis would have been withdrawal from the Euro (and if necessary from the EU), and a combination of deficit spending to plug the cyclical gap and tax increases to plug the structural deficit. I'm amazed that there hasn't been a revolution in Ireland, given the cuts to public spending and benefits which have taken place. If Ireland was in South America the government would have already fallen. Maybe it's time to arm the workers out there.

Nomura's Richard Koo, who is referenced disparagingly by Pritchard, seems to have the right idea when he calls for a huge deficit spending boost to counter the recession. I have yet to read his book The Holy Grail of Macroeconomics (about Japan's "lost 20 years") but it is one of the next things on my list.

Of course it is essential that once growth resumes, countries run surpluses instead of deficits, to reduce the burden of debt interest - and this is where New Labour went badly wrong, because they had a structural deficit - but to call for huge spending reductions now is insanity. It would just turn the worst recession since 1929 into the worst depression OF ALL TIME and probably lead to the complete collapse of Western democracy and its replacement with fascist states under the control of people like the BNP.

Is that really what Ambrose Evans-Pritchard wants to see?


Van Patten said...

Whilst I see where you are coming from here, perhaps you could explain how the approach you advocate differs from that of Gideon Gono, erstwhile governor of the Central Bank of Zimbabwe? Surely the approach you advocate, which seems to me to amount to 'quantitative easing' will just result in rampant inflation?

You advocate running an even greater deficit when the current government has already succeeded in creating the largest deficit (even taking inflation into account) since the Middle Ages. You also seem to confuse symptoms with cause. Surely the key is better direction of Public expenditure, rather than simply pouring money in as a means of countering the recession. As I have said previously the IMF approach is fraught with peril for sure. We can look at Latvia as a prime example of why their 'one size fits all' outlook is inappropriate. I would argue Ireland is in a worse state than the UK because the housing boom there was equally unsustainable but as you rightly point out their presence in the Euro prevented them from raising interest rates to bring their levels of personal debt under control. However, in the UK, we need to take this opportunity to challenge items of expenditure (and innumerable examples can be sourced from Taxpayers Alliance website amongst others) and cut them. (EHRC for example) Fail to do this, and you certainly run the risk of the BNP gaining power. The problems inherent in the current government's approach can surely be seen as the cause of the arrival of 2 BNP MEPs and a host of councillors. Your argument appears to be, had the government spent even more money on them, BNP voters would not have voted BNP. Can you confirm this is your contention?

giroscoper said...

I don't want to dismiss this comment out of hand as you are certainly right that some items of expenditure should be cut. Replacing Trident, ID cards and "mini-Titan" prisons are all pointless, for example.

But I am wary about using the Taxpayers Alliance as a basis for deciding which items to cut as they are a bunch of right-wing nutters looking to cut all benefit spending and introduce a flat tax which would be a massive giveaway to the rich.

As far as EHRC goes the solution is simple: fire Trevor Phillips and appoint a competent chief exec.

At no stage during their campaigning did the BNP suggest that public spending was too high - in fact theirs is a right-wing Keynesian programme along the lines of Hitler in Germany and George W Bush in the US. They argued, rather, that all the money should be spent on white people.

I don't think anyone voted for the BNP because they thought public spending was too high - they would have been more likely to back the Tories or the Libertarian party in that case.