In Defense of Fiscal Credibility

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Yes, I am anti-stimulus, but I would never doubt that government is more than capable of "mitigating the length and severity of recessions" by taking steps that will reinvigorate the economy.
 
That is why I have been calling for spending cuts--and have cited examples in Sweden, Canada, Australia and Finland.

 
YPNation contributor Ethan Pollack is correct. Recessions do cause an underutilization of labor markets. That being said, a fiscal stimulus does not always succeed in getting people back to work. How can we be sure that the jobs "created" by the stimulus match the skill sets of the unemployed?
 
We can’t.
 
As this piece shows, despite the stimulus, "even a salary of $140,000 for senior researchers isn't drawing enough qualified applicants." And that's not to mention the auto worker who can't get a job in renewable energy. You can spend money to bolster the labor market, but what happens when you can't fill the positions? It's a little like increasing the size of the army without new recruits.
 
Regarding interest rates for business: Given the trillions of bad loans banks currently have on their balance sheets, they need to increase the interest rates on the borrowers still in business to pay the costs of those going bust. Warren Buffett has already stated this. Thus, we're subsidizing profits. Sure, the aggressive cuts in interest rates have filtered through, but only as far as Wall Street. It has not reached small businesses.
 
And here is what is so concerning--the failure to prevent banks from using punitive charges and increased interest rates to cover their losses was a contributing cause to the Great Depression. This in turn left consumers short of disposable income and created levels of interest that crippled small businesses. Aggressive banking reform is required, but that’s an issue for another day.
 
As previously stated, government intervention can exacerbate this situation when it too becomes overly indebted, swamps the market with bonds and crowds out credit access to the private sector. Yes, this does happen in a recession.
 
But too much government borrowing means credit flows that would have previously gone to the private sector are being diverted to, as Ethan put it, "ultra-secure U.S. securities.” If you can buy more and more of U.S.A. Corp., why take the risk elsewhere? So the more debt U.S.A. Corp. sells and the more of a comfort zone it creates, the more risk averse the private sector becomes and the spread widens. Government debt exacerbates the situation.
 
Finally, let's take another look at inflation. The data on Treasury yields Ethan cites are correct, but this fall is not that surprising when you consider the tumult and deflation of the past year. We had an excess of demand following the collapse of Lehman Brothers and AIG as investors sought a safe haven. This heightened demand--the highest since 1995--was the reason behind the falling yield.
 
But if you scratch the surface there’s a reason yields have stayed low. It isn't because of more deflation fears or a sign that the economy is recovering, but because the Fed is printing money to buy bonds that then artificially stop yields from rising. The real question should be how long can this be sustained?
 
What fascinates me about markets is they refuse to follow textbooks. There’s always an underlying trend that 99 percent of investors fail to spot. The increase in supply and fears over inflation mean the Fed is struggling to keep Treasury yields as low as possible. The only way they can do this is to buy their own debt, which of course they are doing. That being said, this position can not be continued indefinitely.
 
The longer we go down this road, the longer the pain will be. What I have proposed is a radical cut in spending and a return to some semblance of fiscal credibility in Washington, D.C. In turn, these cuts will pave the way for lower interest rates over a sustained period of time that will not just subsidize Wall Street, but also ease the burden on American households.
 
My initial post was meant to shock and alarm fellow young professionals about the perilous path we are following that will lead to a major increase in the cost of living and a less prosperous future for us and our families. I also cited the ugly consensus we now appear to have about the U.S. deficit. What’s telling is that the rest of the Western world (bar the United Kingdom) has learned a great lesson from the perils of combining a loose monetary system with a burdensome debt.
 
Unfortunately the United States Congress has yet to get that memo.
 
(Image by RaminusFalcon)
 
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