Debt and deficits after coronavirus

A fascinating chart from Getup!

See how Federal deficits in Australia surged during both world wars, as did the ratio of outstanding debt to GDP.  For example, the (Federal) deficit to GDP ratio peaked in 1944 at 20%.  The debt to GDP ratio peaked at over 100% two years later.  The debt to GDP ratio didn't fall because the Federal government ran a surplus (though there was a small one in 1949) but because the denominator in the equation rose.  Debt to GDP  was high in all post-war belligerent economies, not just Australia.  But they understood the thesis that Keynes had made, which was that raising taxes and cutting expenditure to repay debt was counter-productive, because these actions reduced economic activity, so although the deficits naturally reduced as war ended, they didn't attempt to create fiscal surpluses as had been done after WW1.   The truth of Keynes's theory was conclusively demonstrated during the Euro crisis of 2011, when forced deficit reduction led to a "double-dip" recession.

Once again, governments are running large fiscal deficits, to keep economies afloat during the covid crash.  And it will be interesting to see whether "austerity", which has been discredited again and again, will be introduced after the recession is over to pay back sharply higher debt levels, or whether they'll do as most economies did after the war, and allow the ratio of debt to GDP to fall as a result of economic growth.

There is in any case a difference between debt incurred to fund the construction of capital goods (railways, roads, schools, housing, factories) and debt incurred to fund current expenditure (wages and salaries, running costs, etc.)  It makes sense to fund, say, a railway with bonds, repayable over 25 or 30 years.  However, only in the rarest circumstances, borrowing to fund current expenditures is unwise.  This is one of those rare circumstances.

Toiling feebly along

US employment growth in August wasn't exactly robust. and the numbers for previous months were revised down, a bad sign.  But employment tends to lag a little, and this may be the delayed response to the "fiscal cliff".

However, as the chart below shows better than the one above, employment growth this cycle has been extraordinarily sluggish (Chart from Calculated Risk)

But the change in the unemployment rate (shown inverted on the chart, because unemployment rises in recessions and falls during recoveries) is still consistent with ongoing recovery.  I've plotted it against the yoy change in my coinciding index, which tracks GDP and the cycle.

And overtime hours in manufacturing, also a sensitive indicator to the state of the economy, were up in August.

My assessment is that growth continues, though (a) it's very far from a boom and (b) we still have a long way to go before we reach the previous peak. The GFC's consequences are still with us. (As usual, clicking on each chart will produce a bigger version)

World econ resumes growth. At last!

This shows the weighted average PMI indices for the US, Europe, China and (since the beginning of the year) Japan.  Growth is accelerating.  For most of the last 2 years, these indices have been below 50%, indicating recession.

By slashing government expenditure and raising taxes, Europe manged to push its economy back into deep recession.  But that folly is now past.

My take on it is that growth will increase form here, for now.

[See also yesterday's piece, Fiscal Folly]

Fiscal folly

From an article by Joseph Stiglitz in today's The Age newspaper:

While other countries fell into the global recession, Australia maintained strong economic growth, low government debt and a triple-A credit rating. With this record, you might expect the federal election to be focused on how to convert the strength of today's economy into resilience for the future. But instead the political spotlight has fallen on the perceived problem of government debt, with alarming proposals to bring austerity ''down under''.

For an American, Australia's anxiety about deficit and debt is a little amusing. Australia's budget deficit is less than half that of the US and its net debt is less than an eighth of the country's gross domestic product.

Most countries would envy Australia's economy. During the global recession, Kevin Rudd's government implemented one of the strongest Keynesian stimulus packages in the world. That package was delivered early, with cash grants that could be spent quickly followed by longer-term investments that buoyed confidence and activity over time. In many other countries, stimulus was too small and arrived too late, after jobs and confidence were already lost.

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In Australia the stimulus helped avoid a recession and saved up to 200,000 jobs. And new research shows that stimulus may have also actually reduced government debt over time. Evidence from the crisis suggests that, when the economy is weak, the long-run tax revenue benefits of keeping businesses afloat and people in work can be greater than the short-run expenditure on stimulus measures. That means that a well-targeted fiscal stimulus might actually reduce public debt in the long run.

Australia may have successfully dodged the global crisis, but some politicians seem to have missed the lessons it taught the rest of the world. In this election, the conservative side of politics has foreshadowed substantial cuts to the government budget. This would be a grave mistake, especially now.

Recent experience around the world suggests that austerity can have devastating consequences, and especially so for fragile economies. Government cuts have helped push Britain, Spain and Greece's economies deeper into recession and led to widespread public misery.

The youth unemployment rate in Spain is above 50 per cent and the figure for Greece is above 60 per cent. Their tragic experience should be a warning to the world. But even seemingly healthy Germany was pushed into a recession from which it is just now emerging - but it is an economy that is still weaker than it was before taking the "dose" of austerity.

Proposals for substantial budget cuts seem particularly misplaced at this time given that Australia's economy is confronting new global challenges. Commodity prices are softening and growth is slowing in many key export markets. Australia is already facing declining mining investment. The slowdown in economic growth is not the result of flaws in government policy, but of an adverse external environment. It would be a crime to compound these problems with domestic policy mistakes.

Sharp cuts to public spending over the next few years will exacerbate these challenges. Withdrawing government spending as the economy weakens risks tipping Australia into recession and increasing unemployment.

Assuming standard multipliers(1), cutting public spending by $70 billion from an economy the size of Australia's over a four-year period could reduce GDP growth by around 2 per cent and cost up to 90,000 jobs.

Instead of focusing mindlessly on cuts, Australia should instead seize the opportunity afforded by low global interest rates to make prudent public investments in education, infrastructure and technology that will deliver a high rate of return, stimulate private investment and allow businesses to flourish.

Read more here.

(1) In fact the multipliers in those European countries which blindly imposed fiscal austerity have been unexpectedly large.

Read more: http://www.theage.com.au/comment/australia-you-dont-know-how-good-youve-got-it-20130901-2sytb.html#ixzz2e0mZx5AC

June Labor Market

"Or" instead or "our" because it's the US labour market.

I had an estimated increase in payrolls of 220,000 in my calculations.  The increase during the month was less than that, but revisions to the last couple of months pushed up total payrolls in June to more than I had guessed.  When previous numbers are revised up, it tends to be a sign that economic growth is strong.

The chart below shows the average for the ISM and the PMI, both national measures of manufacturing strength.  The ISM used to called the NAPM.   The big question over the last few months has been whether the "fiscal cliff" (a simultaneous rise in Federal taxes, or at least  a return to pre-crisis levels) and a cut in spending would plunge the US back into recession.  Yes, growth did slow a little -- see the slide in the combined ISM/PMI  indicator -- but both it and the three-month change in payrolls have bottomed.

Other labour market indicators retreated over the last couple of months and have rallied:  overtime hours in manufacturing, a very sensitive cyclical indicator, fell and recovered somewhat in June; and even government employment appears to be flattening out, which given the "fiscal cliff" at Federal level is remarkable and implies states and municipalities are hiring again.

"Surprise" ISM May slide

In the US, the ISM index (what used to be called the NAPM index) has had a very close correlation with economic activity over the last 75 years.  Even though manufacturing is now just 12% of GDP, still, it is well correlated.

It fell, surprising the markets, in May.  What's happening seems clear enough to me.  The economy had finally started to accelerate into a sustained economic recovery.  And then the "fiscal cliff" started to bite, and it slowed again.   This dynamic has played out again and again over the last 5 years, right across the world.  Fiscal tightening causes economic slowdown.  Is anybody listening?

QE is safe.  But the share market may not be -- the market is well correlated to economic "surprises" (i.e., what surprises the assembled gurus en masse)  And the surprises have all been negative over the recent period.

4 Ways to leap the Fiscal Cliff

Some good points in this piece

I don't think it makes sense to raise company tax.  But a carbon tax of just $5 a tonne, will raise $34 billion a year, and if it rises by $2 a year, substantially more within 10 years, while also encouraging a decline in emissions.

This is the consequence of ill-advised austerity

Trenchant cuts to government spending and large rises in taxes don't balance the budget, because they cause the economy to go into recession or to deepen the existing recession.

The Greek unemployment rate is now at a new record high of 25.4%.  A year ago it was bad enough: 18.4%.  But it has risen an incredible 7% points in one year, and this isn't the first year of the recession.  It's the fifth.  And its prospects of repaying its debts are no better than they were at the beginning of this whole sorry fandangle.

This is higher than the unemployment rate reached during the Great Depression in the US.  And it is still rising!   Holy ninniebarn!

What a shameful spectacle of gross incompetence by those in charge; incompetence made worse by the fact that not only has it not achieved its target, but it has inflicted scars on Greece which will last a generation.  Pointlessly.

Meanwhile, the same tired old remedy is being proposed to solve the budgetary difficulties of all the other deficit countries (Spain, Italy, the UK, Australia....), and of course we face a "fiscal cliff" in the US where the rabid right cling desperately to their failed nostrums.  Like medieval blood-letting: if the treatment doesn't work you just repeat it until the patient dies.

(You might also want to read Lessons from History)

Lessons from history

I've talked before about the follies of trying to balance the budget during recessions. Here's a new and compelling example from an intriguing and instructive piece from Martin Wolf.


The UK emerged from the first world war with public debt of 140 per cent of gross domestic product and prices more than double the prewar level. The government resolved both to return to the gold standard at the prewar parity, which it did in 1925, and to pay off the public debt, to preserve creditworthiness. Here was a country fit for the Tea Party.

To achieve its objectives, the UK implemented tight fiscal and monetary policies. The primary fiscal surplus (before interest payments) was kept near 7 per cent of GDP throughout the 1920s. This was, in turn, accomplished by the “Geddes Axe”, after a commission chaired by Sir Eric Geddes. This recommended slashing government spending in precisely the way today’s believers in “expansionary austerity” recommend. Meanwhile, the Bank of England raised interest rates to 7 per cent in 1920. The aim of this was to support the return to the prewar parity. Coupled with the consequent deflation, the result was extraordinarily high real interest rates. This, then, was how the self-righteous fools in the British establishment greeted the hapless survivors of the hellish war.

So how did this commitment to fiscal famine and monetary necrophilia work? Badly. In 1938, real output was hardly above the level of 1918, with growth averaging 0.5 per cent a year. This was not just because of the Depression. Real output in 1928 was also lower than in 1918. Exports were persistently weak and unemployment persistently elevated. High unemployment was the mechanism for driving nominal and real wages down. But wages are never just another price. The aim was to break organised labour. These policies resulted in the general strike of 1926. They spread a bitterness that lasted decades after the second world war.

Quite apart from their huge economic and social costs, these policies failed in their own terms. The country went off gold, for good, in 1931. Worse, public debt did not fall. By 1930, debt had reached 170 per cent of GDP. By 1933, it had reached 190 per cent of GDP. (These numbers put the panic over today’s far lower ratios in perspective.) In fact, the UK did not return to its pre-first world war debt ratios until 1990. Why was the UK unsuccessful in lowering the ratio of debt to GDP? Briefly, growth was too low and interest rates too high. As a result, even a huge primary fiscal surplus could not constrain the debt ratio. 

The consequences of this folly were devastating. As a result of economic weakness, Britain lost its place in the world order, going from being the greatest superpower to a has-been.  It was left with an enduring class hatred, which embittered politics and slowed economic growth for two generations.  And how much of the appeasement of the 30s came from the absence of money to pay for rearmament?

There are obvious lessons here not just for the Tea Party numpties but also the the austerity ghouls in Europe.  The West risks negligible growth for two decades while the rest of the world powers ahead, pointlessly  since the austerity is unlikely to cut government debt.  The parallels with the US are frightening   Read the whole piece, it's really worth it.

Labour Market stats for August

Payrolls grew by just 96 K, but previous data were revised down, a sign of economic weakness.  Overtime hours in manufacturing (very sensitive to economic conditions) fell.  Oddly, the unemployment rate fell, but that came from a different survey (of households not firms) and has a much bigger standard error (is more "noisy") than the establishment ("payrolls") survey, and in any case can fall if people give up looking for work and exclude themselves from the labour force (which they did in August).

For now, I'll just show the unemployment rate chart, because it encapsulates the problem.

Note how in previous recoveries the unemployment rate has fallen sharply.  This has been the great strength of the American system: unemployment might soar during recession, but it also falls just as fast in recovery.  This time, its not happening.  Coupla points:

• A sluggish recovery is entirely to be expected when an economy has to rebuild its balance sheets because of too much debt.
• These numbers mean that Obama might well lose the election (forget all the hoopla, in years of strong economic growth, hoi polloi re-elect the incumbent or his party; in bad years they don't)
• If the Romney gets in, the Tea-Party ideology which dominates the Repubs will cause the "fiscal cliff" I've muttered on about before.  GDP will fall at least 3%.  At least.
• Which will push the unemployment rate way above its previous highs.  In fact, to post-war highs, to levels not seen since the Great Depression in the 30s. 
• Very NOT good for shares. 

Jackson's Hole

Yep.  It really is called that.  Every year at about this time, the heads and support staff of the world's major Central Banks retreat here to discuss the problems facing the world economy and what they should do about it.  Ben Bernanke said a day or so ago that he was very concerned about the unemployment rate in the US and how slowly it's fallen this year.  And he said that the Fed would if it was necessary do something about it.  On the strength of this, share markets rallied, and the bulls swished around all excited.  Delicious animals.

The problems with o'erweening optimism are these:

• Major markets are at previous highs (see charts).  To rise through these highs will require either much better economic data and/or serious, credible stimulatory measures in the US and China and Europe. Comforting words from Ben are not enough. Not any more.
• The Chinese share market, though, isn't at previous highs.  It's slumped.  And that's because the Chinese leadership is embrangled in a leadership struggle, one that happens every five years, but which has had the bad taste to happen now when the Chinese economy is slowing sharply.  No one wants to make key decisions until they know who's going to be boss.  This is complicated by a shift in the Chinese growth model from export-led growth.  Lots of big decisions and no one to make them, probably until November.
• The US (20% of the world economy) is still facing a "fiscal cliff" in January, when the rolling back of previous tax cuts and mandatory expenditure cuts will slice 4 or 5% from GDP.  We've all seen the result of swingeing austerity in Europe.
• And, talking of Europe, even though a dim awareness that deep expenditure cuts and tax increases are counterproductive seems to be percolating through even to the Germans, so much needs to happen to generate a recovery -- an end to fiscal austerity; a common bank oversight model for the whole Euro zone; massive quantitative easing; and rate cuts.  They will happen in time, but while we await, markets could get very skittish.  Not so good, kitty malloona.  

I'm taking some money off the table and watching sectoral swings like a ... fund manager should.   Perhaps share markets will just go sideways for a while and then resume their uptrends.  And perhaps not.

 

The Party Platform

The Republican Party turns sharply right.  Looks like the "fiscal cliff" is more likely.

Time to spend big

US 10 year Treasury bond yields are at decadal lows.  Forget that, they are at century lows.  Hard-headed investors are saying that they will lend money to the US government for just 1.4% per annum interest.  For CPI linked bonds, the interest rate is negative, in other words, investors are willing to pay the Federal Government to lend it money.  Bit like working as a waiter at a grand resto: you pay for the privilege (because it's assumed you'll make more than that in tips).

As Paul Krugman says, now would be a splendid time for the US government to build needed infrastructure: roads, schools, high-speed trains, airports, green power stations, ports, etc, etc.  This would add dramatically to demand in the economy but would also increase supply.  Eisenhower's interstate highway construction program is estimated to have added 1.2% per annum to the growth rate ( a huge increase when growth is around 3 or 4%) because of its impact on the overall capital stock.

Instead, the tea-party numpties are planning to cut spending drastically in the new year, the so-called "fiscal cliff", which will contract demand sharply precisely at the time when it's not a good idea.

We need a new FDR.   The collapse in bond yields is a splendid opportunity to transform America.  But it won't happen, because conservatives have gone from being pragmatic to true believers, and the US (and the world) is worse off because of it.

Click on chart to enlarge