Saturday, August 28, 2010

Germany Proves the Keynesians and Obama Wrong

Keynesian has been one of the predominant economic theories since the end of WWII. The United States is about 10 years behind Europe primarily because of the post WWII economic boom that occurred in the US, countering the Keynesian doom-sayers who predicted high unemployment and slow growth after the war. This delay has allowed economists in the US to look at Europe as kind of a crystal ball into the future. In March/April of this year there was a meeting of the G20 in England. There Obama was rebuffed for his Keynesian ways and was told Europe had had enough of high unemployment and low GDP, and rather than spend themselves into prosperity, they were going to tighten there belts and cut spending toward a path of austerity.

Paul Krugman, one of the loudest voices for Keynesian economics was beside himself. In a now infamous OP-Ed named “That ‘30s Feeling”, Krugman lambasted the Germans. “What’s the economic logic behind the government’s moves? The answer, as far as I can tell, is that there isn’t any. Press German officials to explain why they need to impose austerity on a depressed economy, and you get rationales that don’t add up. Point this out, and they come up with different rationales, which also don’t add up.” The reason Krugman was so adamant against austerity is one of Keynesian’s primary pillars is stimulus or perish; but he saw all this cheap money available to the Germans, “The key point is that while the advocates of austerity pose as hardheaded realists, doing what has to be done, they can’t and won’t justify their stance with actual numbers — because the numbers do not, in fact, support their position. Nor can they claim that markets are demanding austerity. On the contrary, the German government remains able to borrow at rock-bottom interest rates.” Krugman went on to forecast,“There will, of course, be a price for this posturing. Only part of that price will fall on Germany: German austerity will worsen the crisis in the euro area, making it that much harder for Spain and other troubled economies to recover.”

David Brooks wrote in his Op-ed piece “The Parent Model”, the German financial minister countered the Keynesians with, “Governments should not be addicted to borrowing as a quick fix to stimulate demand”. (No wonder Krugman hit the ceiling!). The Germans instead were looking reduce debt, balance budgets and increase confidence. Well it’s been 5 months and what has happened? The US is still mired in a recession with 9% employment and a flat GDP. Germany on the other hand has seen 9% growth in one quarter and unemployment has fallen. Brooks went on to say, “The results do underline one essential truth: Stimulus size is not the key factor in determining how quickly a country emerges from recession. The US tried big, but is emerging slowly, The Germans tried small and are emerging quite nicely." Obviously this is only one quarter and as Brooks mentioned, 9% is not a sustainable level of growth, but I'm sure Obama would rather have seen similar results prior to the upcoming November elections.

Since the Keynesians and Paul Krugman have been tone deaf to current economic trends, economists have been looking in other directions. One Global Investment company that has been gaining a lot of respect is PIMCO and their New Normal. "The result is a prolonged pause, or in some cases, a violent reversal in certain concepts that markets had taken for granted. We referred to it as the demise of the “great age” of private leverage, asset- and credit-based entitlements, self-regulation, policy moderation, and shrinking direct government involvement. Not surprisingly given the extent of the gains that were privatized and the losses that are now being socialized, the demise is occurring in the context of popular anger, confusion and what one of our speakers called “a morality play” in parliaments around the world." PIMCO describes this economic world view as a result of what they termed the Keynesian "end point;" from Bloomberg , “Time, devaluations, and debt restructurings might be the only way out for many nations,” Crescenzi wrote in an e-mailed note titled “Keynesian Endpoint” that referenced the Great Depression era economist John Maynard Keynes. Debt-fueled spending programs aimed at combating the global financial crisis of 2008 are among policy tools now “being seen as a magic elixir that has morphed into poison.”

To be fair to John Maynard Keynes, there is little doubt that we would consider it laughable that Paul Krugman is a self described neo-Keynesian. Keynes was a pragmatist and was continually reconstructing his theories and determining exactly how much control the government need take to steer the economy. He did not believe in any absolutes and was not the political harlequin Paul Krugman has become. Perhaps Krugman should listen to Keynes when he said, "When the facts change, I change my mind. What do you do, sir?"

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