Ben Bernanke’s machinations since the financial crisis began are widely celebrated as having saved the financial markets from complete ruin. Question is, was preventing the ruin of an over-leveraged, non-transparent, and bubble-driven financial system really the best path? For that matter, did the actions of Bernanke and company simply delay the day of reckoning and/or ensure that this day will be even more severe? Efforts to divine an enigmatic yesteryear notwithstanding, the reality is that as policy makers veer down one path we are precluded from knowing what the terrain would have been like down the other, with all of the ‘could have’ and ‘would have’ impediments limiting what can be said with conviction…
What can be said is that it is customary for those who view history with a predetermined bias to evoke the path not travelled to substantiate their point of view. Case in point, while citing the popularBlinder/Zandi report Treasury Secretary Tim Geithner recently noted that, “the combined actions since the fall of 2007 of the Federal Reserve, the White House and Congress helped save 8.5 million jobs and increased gross domestic product by 6.5 percent relative to what would have happened had we done nothing [bolds added].” To begin with, not only is it absurd to theorize “what would have happened” if policy makers did nothing, it is even more absurd to point to today’s dismal economic recovery and contend that things have improved when weighed against _______. To turn this asinine dollop of speculation around: just as the stock market and subsequent housing market bubbles previously disguised tragic policy decisions (or lack thereof) Into a strong economic upturn, the supposedly laudable actions of policy makers during the recent crisis have actually set in motion the destruction of the U.S. financial system and U.S. dollar. Thus, of what utility is saving jobs and enhancing GDP in the short-run if the means by which these feats are achieved causes irreparable long-term harm to the economy and currency?
Suffice to say, the concept of paths taken, and not taken, is worth bearing in mind when discussing tomorrow’s policy choices. In the case of the U.S., policy makers are likely to continue to spend, enslaved as they are to the idea that until U.S. interest rates skyrocket and/or the dollar is destroyed there is always more room to borrow and print. As for the conclusion from Austrians (or Auesterians) that deficit spending/money printing today will only make matters worse tomorrow, U.S. policy makers are unlikely to pay attention to the austerity cries. After all, the market has made it clear that austerity is a strategy undertaken only by the weak.*
This debt/austerity debate, which has gone viral in recent months, has sparked an energetic tête-à-tête among economists. And while it may appear of limited utility for the average investor to wade into this debate, the reality is that most asset classes have, and will likely continue, to feast or famine on the choices of global policy makers. To summon Shakespeare, ‘to deficit spend or enact austerity? – this is the question!’ A question that lends itself to many contradicting answers and can be based not only upon individual country-by-country situations but, perhaps also, perceptions…
“You know what? It doesn't matter. None of this—this so-called 'money'—really matters at all...It's just an illusion. Just look at it: Meaningless pieces of paper with numbers printed on them. Worthless." Ben Bernanke. The Onion
The Apostles of Keynes
Paul Krugman is the ring leader when it comes to idolizing Keynes. In his June 27, 2010 article, entitled “The Third Depression”, Krugman noted, “this third depression will be primarily a failure of policy. Around the world — most recently at last weekend’s deeply discouraging G-20 meeting — governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending.” Other notables latching on to similar themes include De Long, Stiglitz, and John Makin. Mr. Makin, scaring even Krugman, recently noted “By later this year, persistent excess capacity will probably create actual deflation in the United States and Europe…” and“because all governments are simultaneously tightening fiscal policy, growth is cut so much that revenues collapse and budget deficits actually rise.”
Ironically, even those not usually known for waving their Keynesian pom-poms tend to agree that austerity is not the short-term answer. For example, the level-headed Jeremy Grantham says, “You don’t have to be a passionate follower of Keynes to realize that to rapidly reduce deficits at this point is at least to flirt with a severe economic decline….I recognize that in this I agree with Krugman, but I can live with that once in a while.”
Last, but definitely not least, are U.S. policy makers, which are almost universally pro-Keynes.
The Rebirth of Hayek
In a recent FT article entitled “Today’s Keynesians have learnt nothing”, Niall Ferguson says that“People are nervous of world war-sized deficits when there isn’t a war to justify them”, adding “Those economists, like New York Times columnist Paul Krugman, who liken confidence to an imaginary “fairy” have failed to learn from decades of economic research on expectations.” Mr. Ferguson personifies the anti-Krugman point of view; a view that is supported by recent history (i.e. unprecedented fiscal and monetary stimulus actions since 2008 have done little to engender a strong economic recovery).
Along with Ferguson there are numerous European austerity enthusiasts, most notable Britain prime minister David Cameron and president of the European Central Bank, Jean Claude-Trichet. Mr. Cameron, perhaps eying the crown of Mr. Austerity, shocked the markets (in what turned out to be a good way) when his emergency budget laid out the largest cuts in spending since World War II. The basic proposal from Cameron, a template that would give any U.S. policy makers a heart attack, was“about four pounds in spending reductions for every pound in tax increases.” As for Mr. Trichet, in writing “Stimulate no more – it is now time for all to tighten”, he discussed the ‘fiscal buffers’ that were in place before the financial crisis (insinuating that these buffers are no longer in place), and added quite bluntly, “there is little doubt that the need to implement a credible medium-term fiscal consolidation strategy is valid for all countries now.” Cameron, Trichet, and even Germany’s Merkel represent a unified European front for austerity, and are the major source of a de-unified outlook for the developed world.
Then there is a growing mob of anti-Keynesian thought coming from some unlikely sources, including the likes of Alan Greenspan. In a recent WSJ Op-Ed Mr. Greenspan contended, “We cannot grow out of these fiscal pressures” adding, “The United States, and most of the rest of the developed world, is in need of a tectonic shift in fiscal policy. Incremental change will not be adequate.” It goes without saying that if Easy Al’ was still running the Fed he would not be uttering what many policy makers would consider heresy.
Also highlighting the limits of Keynesianism has been FOX’s Glenn Beck, who, after reviewing ‘Road to Serfdom’, helped catapult Hayek’s 1945 text to number one on Amazon. Finally, there is a mob of individuals that FallStreet follows that despise Keynesian thought, including Ron Paul, Peter Schiff,Mish, Gary North, etc.
Can Both Ideologies Be Right?
Strangely enough, followers of both Keynes and Hayek are well aware of their limitations. For example, even the Krugmans acknowledge that deficits are a long-term problem that should be dealt with (but only after greater amounts of deficit spending set the economy down a firmer recovery path). Similarly, it is difficult, Ron Paulites perhaps being the exception, to find an Austrian that is dedicated to the pursuit of jarring policy changes in the name of Hayek (i.e. if the Fed started raising interest rates, a throng of government-run institutions were allowed to fail, and the U.S. budget was immediately balanced the unmitigated chaos that would ensue is unthinkable). In short, what is at issue are not the sound principles of austerity, but the pace of the austerity embrace. Keynes says ‘definitely not now!’, while Hayek remarks ‘if not now, when?’
A Futile Debate?
Despite today’s austerity noise there is no collection of U.S. debt holders that have achieved the clout required to demand austerity from America. For that matter, it is exceptionally difficult to foresee the U.S. being compliant when, and if, foreign austerity demands do arrive. In other words, it appears likely that we will follow the ebb and flow of the current path until the destruction of dollar, intentional or otherwise, comes to pass.
In this regard the deficit spending/austerity debate is somewhat of a red herring in that it is supported by the flimsy assumption that policy makers must indulge theoretical models relating to debt thresholds while at the same time not completely discounting current market forces. The contention is akin to ‘if you ignore rising debt levels for X amount of time you do so at your peril!’ Problem is, no one is all too sure what X is…
“Treasurys are thus free of credit risk. But they are not free of interest rate risk. If Treasury net debt issuance were to double overnight, for example, newly issued Treasury securities would continue free of credit risk, but the Treasury would have to pay much higher interest rates to market its newly issued securities.” Alan Greenspan
Conclusions
The U.S. dollar can be seen as being both the lynchpin of the great fiat money experiment and the weakest link of all fiat money. And yet despite all of the jabbering by economists and analysts, neither Keynes nor Hayek-based speculations can lay claim to having accurately mapped the recent path of the markets, let alone the coming path. Many today think that Keynesian thought has reached its limits and contend that USD hegemony has entered its final countdown. But few even attempt to offer a precise depiction of how transference to a new monetary regime will unfold. Can there really be an end to Keynesianism without the beginning of something else completely different? Conversely, the insights of Hayek are indeed a common sense blessing that policy makers would be wise to heed, but they can also act as a burden. After all, remembering that the market has made it clear that austerity is a strategy undertaken only by the weak*, why should the strong indulge in Hayek? Didn’t the 20-years of Hayek inspired IMF mandated shock therapy in the third world cause more harm than good?
Again zeroing in on the U.S., the deficit spending/austerity perspective lends itself to two considerations: in theory the U.S. must soon stop spending/printing or it will wreck its currency and economy, but in reality since all U.S. debt is denominated in USD the U.S., unlike those European nations tied to the Euro, can always print. In other words, it does not take a leap of faith to contend that the U.S. will print, and that tomorrow’s question will not be focused on deficit spending or enacting austerity per se, but of devaluing the dollar or repudiating debt. Until then, was preventing the ruin of an over-leveraged, non-transparent, and bubble-driven financial system really the best path? Really???
“We can always pay our debts in the United States as long as we borrow in dollars. We just keep printing more dollars. The Greeks can't do that or other members because they are tied to the euro...” Warren Buffett
