Economic Growth According To The World’s Leading Economists

10/05/11 Paris, France – We were on the edge of our chairs yesterday. We wanted to see if the Dow would crash through the 10,000 barrier. A break below 10,000 would probably hit the markets like a drone attack on a birthday party…

…perhaps causing investors to panic…and the feds to do something really stupid.

The feds are getting ready. They’re being egged-on by some of the world’s leading economists. Nobel prize winner, Peter Diamond, for example, urges the feds to spend more money on infrastructure projects. Richard Koo, a top economist in Japan, says US government spending is the only thing that can prevent a deeper downturn (more below…). And, of course, there’s Paul Krugman! We know what he thinks…spend, spend, spend…tax, tax, tax…control, control, control, control.

Mr. Bernanke described the nation’s economic health in bleak terms, saying that “the recovery is close to faltering,” and suggested that avoiding another recession might require fresh government action. “We need to make sure that the recovery continues and doesn’t drop back,” he said.

Such talk from a Fed chairman usually means the central bank is preparing to reduce interest rates, and Mr. Bernanke said that the Fed was not ruling out such a step. But on Tuesday, as at other recent appearances, he made clear that his remarks were aimed at the rest of the government.

Mr. Bernanke has repeatedly called on Congress to adopt a plan for paying down the federal debt, as well as for reducing inequities and loopholes in the corporate tax code, two ideas that enjoy wide support among economists. On Tuesday he also focused on housing policy, suggesting that the government could help underwater homeowners refinance and also improve the availability of mortgages for potential buyers.

The central bank, he said, “is prepared to take further action as appropriate to promote a stronger economic recovery in the context of price stability.”

Yes, all these economists and economic officials still believe in MORE. If we just spend more money…they believe…we’ll end up with a healthier economy which will give us all more stuff!

Of course, it makes sense. They are the guardians and beneficiaries of our dinosaur institutions. Mr. Bernanke’s #1 job is protecting the banks. Mr. Geithner’s job is protecting the flow of tax revenues to the government. Mr. Krugman’s job is to protect his own reputation and revenue stream — both of which lean on more Keynesian spending. All these dinosaurs need more. They believe in more. More is all they know.

…enough credit…enough spending…enough investing…enough regulation…enough debt…enough central planning! It’s stuffed. It’s fed up!

But yesterday, stocks rose. The Dow put another 153 points between it and the 10,000 mark. We’ll just have to wait to find out what happens when it falls below.

Gold, meanwhile, lost $41. We’ve been expecting gold to fall. It has fallen. But not as much as we anticipated. But, heck, we’ve got time. We can wait.

The headlines, however, completely misinterpret the situation. “Gold bugs battered…” says one. Battered? Do you feel battered, dear reader? If so, call our new Battered Goldbug Hotline. We just set it up for dear readers like you.

Money Magazine interviewed Richard Koo, chief economist with Nomura Research Institute. We’ve been following Mr. Koo for years. He was one of the few economists who seemed to understand what was really going on. He knew that the US was not suffering from a ‘normal’ recession, but from what he calls a “balance sheet recession.” People have too much debt. They need to work it down. In the meantime, prices go down…along with GDP growth.

Typical recessions are part of normal business cycles, when overconfident businesses overproduce and then have to cut back. This is what I call a balance-sheet recession. It’s caused by an overload of debt.

It’s a very rare type of recession that happens only after the bursting of a nationwide asset bubble, like a real estate bubble. Once the bubble bursts, the debt remains. The assets, in this case homes, are underwater; their prices are way down, but all the consumers’ original debt remains.

Right now consumers are using their cash to pay down their debt. The economy is depressed because no one is borrowing or spending. Consumers don’t want to borrow, even at [very low] interest rates. And lenders don’t want to make loans to consumers who will struggle to pay them back. You need fiscal stimulus. That means the government should borrow and spend the money in the private sector.

When Japan fell into recession about 20 years ago, we had no idea what was happening. Interest rates were lowered to zero, but the economy still did poorly.

Unfortunately, Mr. Koo believes he can manipulate an economy…and get it to do what he wants. He thinks the secret, in a balance sheet recession, is fiscal stimulus:

Every time the government stimulated the economy, it rebounded nicely. Then when they pulled back, it lost steam again.

Some people look at Japan and say the government spent huge sums on public projects and there was no real growth, so spending didn’t really cure the economy.

The early ’90s recession in Japan was far worse than people realize. Commercial real estate prices nationwide in Japan fell 87% from the peak. Imagine US housing prices down 87%. The fact that the Japanese government halted what could have been an enormous drop in GDP in the early ’90s speaks to the success of its economic policies.

The Japanese made a horrendous mistake in 1997. The Organization for Economic Cooperation and Development and the International Monetary Fund said to Japan, “You are running a huge fiscal deficit with an aging population. You’d better reduce your deficit.”

When the government cut spending and raised taxes, the whole economy came crashing down.

I see exactly the same pattern in the US today. If the government acts to cut the deficit while people are continuing to pay down their debts, then we could have a second leg of decline that could be very, very ugly.

He’s right. It could get very ugly. The economy could die. But you think that’s ugly? Mr. Koo ain’t seen nuthin’ yet. In order to keep the Japanese economy alive…the Japanese feds took up the savings of an entire generation of workers. They spent the money on various projects of doubtful worth. Now, they have no money. Just debt. What will they tell the workers when they want their retirement money back?

"If the government acts to cut the deficit while people are continuing to pay down their debts, then we could have a second leg of decline that could be very, very ugly. "

I agree.

However, further stimulus could lead to (intolerable) high inflation or even hyperflation.

So...

What to do?

...the Japanese feds took up the savings of an entire generation of workers. They spent the money on various projects of doubtful worth. Now, they have no money. Just debt. What will they tell the workers when they want their retirement money back?"

Is this different than what has happened to our Social Security funds?

When the government cut spending and raised taxes, the whole economy came crashing down.

Do you spot the missing piece? The Japanese, he says, cut spending and raised taxes. He compares that to Americans cutting the deficit and paying down debt. The two have no common denominator.

He also ignores, as do they all, the fact that the Japanese Central Bank has kept the supply of Yen stable for years, now. A stable currency has led to falling prices (increased purchasing power) and a GDP which doesn't increase. How could it? There aren't any more dollars.

The Japanese are enjoying a rising standard of living, but the Keynesians can't see it, because the number of yen aren't increasing.

Leave taxes (federal income) absolutely the same to allow business and personal planning. Then dramatically cut spending to live within the tax revenues (spending). The economy doesn’t crash, because most government spending ends up in the pockets of connected elites or wasted.
As waste is eliminated in a streamlined national budget, money flows to productive uses, eventually improving it. Keep taxes flat, and use the increasing revenue of a growing economy above that baseline tax revenue to pay off national debt.

"Then dramatically cut spending to live within the tax revenues (spending)."

Entitlements are the biggest parts of the US budget...cut any of those and you have civil unrest...

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