We Need Fiscal Credibility, Not a Fiscal Stimulus

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I have met libertarians at Cafe Berlin, in Washington, D.C., on a Tuesday, conservatives in the St. Paul Public Library on a Wednesday, and Republican Party staffers in a number of bars each Friday, and never once has someone uttered the words "let the economy burn."
 
Unfortunately, Ethan Pollack seems to be promulgating the myth that those of us on the right who opposed President Barack Obama's $787 billion fiscal stimulus are economic "nihilists" who appear content to see people lose their jobs and watch the economy crumble. For even if the public does not understand the complexities of recessions, the rhetoric emanating from Washington suggests that few policymakers come even close to gauging what a recovery looks like.
 
One thing I will say is that the economy did not need a fiscal stimulus-- it needed a fiscal diet. You only have to look back at the fiscal profligacy of the Bush administration to see that Congress has been high on stimulants for years. It's now an economic necessity to go cold turkey.
 
A little more than a decade ago, the political establishment appeared to have finally got the message that deficits destroy economies. But what we have now is an ugly bipartisan consensus in Washington whereby both Democrats and Republicans are towing the Cheneyism that "deficits don't matter.” To expand on Ethan's analogy, the fire continues to spread not because of economic nihilism on the right, but because debt is proving to be an ideal form of kindling.
 
We don't have to look too far to see how loading up future generations with a burdensome level of debt can wreck havoc on an economy. In the mid-90s, Sweden was on the cusp of bankruptcy before the left-wing Social Democrats initiated a bipartisan consensus on how to cut spending and tackle the deficit. Governments in Canada, Australia and Finland have also taken similar measures in the past.
 
Although the Swedes are hardly averse to spending money in order to stimulate the economy, they can afford to do this through a combination of fiscal conservatism and a robust trade surplus. While addressing the issue of spending money to stimulate growth, Jens Henriksson, one of the architects of the Swedish initiative, said that "if you argue like that you have to be consistent with the times and be just as strong an advocate of running a surplus in the good times." We can hardly say this of the two parties in the United States.
 
But the problem with using a fiscal stimulus to halt the "vicious cycle" to which Ethan refers is that when almost a trillion dollars is channeled to the state inevitably the rest of the private economy is starved of the funds it needs to grow. There is also the likelihood that government intervention will crowd out private business and stymie competition, just like the Tennessee Valley Authority did some decades ago.
 
Given that the government is the lender of last resort and therefore highly unlikely to default on an obligation, banks will become more risk averse and rein in their loans to the private sector. If you don't believe me, just ask a small business owner about their interest rate after the fiscal stimulus. It's unlikely to have gone down. In fact, it’s probably at record levels.
 
That being said, the only way the heavily-indebted lender of last resort can avoid defaulting and finance its fiscal stimulus is through selling its bonds on the open market. It can also buy its own bonds, also known as Quantitative Easing.
 
Having already embarked on an aggressive period of QE, the United States will soon realize that creating money out of thin air has its drawbacks. Just look at the Weimar Republic. It depresses the currency and makes imports much more expensive. (Yes, the cost of exports goes down, but what does the United States plan to sell other than bad debt?)
 
And once the government stops QE, the cost of government borrowing will soar because they lack the means to keep bond yields low. Credit in the public sector will freeze up, and then a more severe sclerosis will occur in the private sector. An increase in the money supply without an increase in productivity will almost certainly lead to inflation and interest rate hikes in the next two years. This double whammy will kill consumers and restrict what little disposable income they already have. Therein lays your real consumer crisis.
 
Without a healthy balance sheet of its own, the U.S. government imperils the health of small businesses when it finances its bloated budget and fiscal stimulus. Of course, it is the American people that will end up paying for it in the shape of inflation and higher interest rates. The only road to recovery is through regaining fiscal responsibility, a sustained period of spending cuts and a gradual reduction of the money supply.
 
How doing the exact opposite is regarded as “responsible” is beyond me. For without even attempting to restore fiscal responsibility, our policy makers have set us on course towards a more perilous path--stagflation.
 
(Image from Cartoosh.)
 
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