“While the crash only took place six months ago, I am convinced we have now passed the worst and with continued unity of effort we shall rapidly recover. There is one certainty of the future of a people of the resources, intelligence and character of the people of the United States—that is, prosperity.”—Herbert Hoover, at the annual dinner of the Chamber of Commerce of the United States, October 2, 1930.

The G-20 meeting broke this week with a mixed bag of results for Friedmaniacs (Hayekanistas?) and Keynesians to ponder. Responding to perhaps no more than a perception that it would be electorally wisest just now to favor austerity measures to deflect national deficits, the world’s politicians, while paying lip service to the need for recovery from a two-year global slump (as if a non-recovery from same were an option), have veered toward deficit-reduction over stimulus-aimed deficit spending. Some nations—Greece, Spain, Portugal, Ireland—have little choice in the matter and must raise taxes and reduce government spending despite the at times ferocious response of their citizens. No one is lining up to lend them any more cash to get over this crisis.

Other nations are making a pre-emptive strike toward austerity apparently believing it is preferable to take their fiscal lumps now with the expectation the suffering will be worth it if it means a stronger foundation for future growth. Despite President Obama’s exhortation to the G-20, and indirectly to Congress, to stay the course on deficit spending to better propel what has been by all measures a fragile economic recovery, the United States seems likewise drifting toward deficit reduction as national policy. It would be more reassuring if that policy drift seemed propelled by clear economic thinking than by political projections of the voting mood going into 2012.

The muddled results of the G-20 meeting suggest that while we may still all be Keynesians now, Hayek harkens, and many politicians think they can have it both ways, alternating between a hands-off approach (although not spending money is a kind of intervention of its own) and bursts of market-adjustments via government spending, a confidence that government policy can fine tune the recovery as we go along. If so, we could be witnessing the beginning of a third path toward recession recovery that attempts to thread between Keynes and Hayek.

Or we could just be witnessing history repeating itself. Poor Herbert Hoover gets much of the blame for the Great Depression which followed on the worn-out heels of the Crash of ’29, but he likewise seemed to tinker with government intervention and deficit avoidance in the years before the worst of the Depression. Complicit with Congress, Hoover may have raised taxes (actually rolled back previous cuts) and tariff barriers in an attempt to contain the emerging depression, but he also initiated government interventions meant to spur housing construction, reduce foreclosures and create jobs. Sound familiar?

The N.Y. Times’ Paul Krugman worries that a populist-inspired reawakening to the need for deficit discipline—a discipline that had been abandoned without controversy as the nation wheeled between two unfunded wars and advanced tax cuts that obliterated a fiscal surplus curve—is most likely to produce a third depression at this delicate stage in the nation's recovery. This one may not be as materially brutal as the Great Depression, but it could be realized as a long-term period of reduced economic activity, persistent unemployment and a progressively diminishing position for the nation’s most vulnerable citizens. Casualties have already been produced by the renewed interest in deficit reduction. Although the House managed to pass an extension of unemployment benefits for approximately 1.2 million Americans, the Senate was unable to similarly respond as a united block of Republican senators and one Democrat, Bob Nelson of Nebraska, allowed unemployment benefits to expire despite the persisting malaise in the U.S. private employment market. The newly empowered British Conservatives are targeting the U.K.’s welfare benefits in their first foray into austerity land.

The months ahead will be precarious indeed. Early signs are mixed: austerity measures in Ireland have threatened to thoroughly vanquish the Celtic Tiger, but data released today record a 2.7 percent growth quarterly growth, the first after eight quarters of sharp declines. New leaders like Britain’s PM David Cameron seem aware of the dangers before them but coolly confident they can adjust as the challenges present themselves. Let’s hope that confidence is not misplaced. I’d hate to see Cameron endure, like poor Herbert before him, an unanticipated early retirement.

Comments

Tom Maher | 7/6/2010 - 10:25am
Economic reality trumps all economic theories. The word being used throughout the U.S. governemnt is "unsustainable" by people on the left, right and center including the Federal Reserve. Presidents Obama has appointed a "Fiscal Commission" to study how the Federal Budget can be made sustainable over even the short run.

The Federal Budget for the next fiscal year projects a 1.3 trillion dollar deficit for 2011 alone according to the President's Office of Managment and Budget. That means the U.S. will have to borrow an additonal 1.3 trillion dollars to finance government operations in FY 2011.

Trillion plus dollar federal deficits are expected for the next several years. The porjection is for the U.S. to have a 20 trillion national debt in the next five years. This annual trillion dollar expansion of the national debt is "unsustainable". Unless something is done to stop these expected annual trillion dollar budget deficits the United States will experiece like Greece unable to get continued fiancing for its hugh national debt. A day of reconing faces the United States government finacing as never before.
Tom Maher | 7/6/2010 - 1:27am
This very week severe austerity measures will be imposed on Greece by the "euro-zone" part of the European Union and the IMF. Very sadly Greece can not raise enough money from taxes and credit to pay for its elaborate government services. To get the bailout money it needs, Greece must institute drastic and very unpopular auterity measures, cutting government spending across the board, including salaries and pensions. These proposed measures have caused serious civil unrest in Greece. Greece continues to have violent rioting in the street of Athens. People have been killed and property distroyed for the last two months.

These are very serious economic events threatening the stability of the euro currency and the institution of the European Union. It remains to be seen if the bailouts will work.
Stanley Kopacz | 7/4/2010 - 1:22pm
The ideas of the eighties haven't worked, either.  Maybe we can't afford multi-trillions for war anymore.  Then we can try anybody's economic ideas again. 
Tom Maher | 7/4/2010 - 12:54am
The New York Times on July 3, reports some last minute political problems with a member nation of the European Union's is delaying final approval of the 750 billion euro "bailout fund". All the 15 nations of the European Union have approved the fund and the required governemnt spending cutbacks except Slovakia.

Slovakia's politicians are reluctant to sign on to the bailout because, as with other EU nations, the emrergency bailout of Greece, Spain, Portugal, Ireland, Italy, etc. is resented. The countries recieving most of the funding are all wealtier than Slovakia. However Slovakia will give its necessary signature by Thursday when the failout fund is schedule to become operational.

So the 15 nation EU is not thinking of Keynes deficit spending anymore. And politcally bailouts are just as unpopular in these EU nations as they are in the United States.

The states with fiancial problems and big debts in the United States such as California and Illinois are not likely to get much sympathy or bailouts from Congress. The ideas of the 1930s are just not workable anymore.
Stanley Kopacz | 7/1/2010 - 12:32pm
"I do not agree with this statement as very few people do what they consider irrational."
Of course, everyone thinks they are being rational, or at least rationally pursuing their appetites, which they usually unthnkingly consider rational.  But, consider the people of Greensburg, Kansas.  Several years ago, the town was wiped out by an F5 tornado (330 mph wind speed).  I don't know how many deaths.  The people of the Monolithic Dome institute pitched their Dome Homes to them, which can resist winds up to 1000 mph.  They sold not a one, because they look different, not bad, but different.
We are rational creatures, but that rationality mostly floats on a sea of unreflected upon appetites and opinions.
Anonymous | 7/1/2010 - 12:15pm
''Unfortunately, the major part of human behaviour is irrational''
 
I do not agree with this statement as very few people do what they consider irrational.  A good bit of my career depended upon knowing what motivated people and I spent a lot of time studying it.  Some obviously do make irrational decisions but what appears irrational to some has a very logical explanation to the person.  It may be based on false information or a misguided opinion but it is seldom irrational.  Also our mood changes dramatically from time to time and based on what one's mood is, a person's decision could be different.  Someone who is happy at the moment is more likely to agree with you as when I knew when to ask my father for a few bucks to help me out on a date.  Always best after I had helped him on something.  Was my father being irrational?
 
By the way I once owned an MGB when I was a young Naval officer but traded it in for a Volkswagen bug when I went to graduate school.  I didn't consider either an irrational decision.
Stanley Kopacz | 7/1/2010 - 11:44am
"Economics is based on human behavior and there still is much mystery in human behavior"
Unfortunately, the major part of human behaviour is irrational.  And a large part of this is found in the financial markets, more akin to bovine herd behaviour than something you'd expect of the apex of creation.  Thus financial bubbles and subsequent collapses.  Knowledge of the laws of probability and Skinner boxes keeps me out of casinos.  Yet they are well populated.   The desire for a quick buck is the basic mentality today.  If the economy is based on human behaviour, would rational behaviour make for a better economy or .....
"Do Economists have an answer why building junk leads to prosperity?"
Ed, There's no doubt about it when you see all the junk in stores that people buy.  If people only bought what they needed, would the economy collapse?  Is that the present problem?  I could have afforded to buy sports cars when I cared about such things, but I bought Chevy Impalas and Novas instead and ran them into the ground, rebuilt them and then ran them into the ground again.   Was I unamerican?  Is frugality, considered a virtue in the early years of the republic, now a subversive activity?
Tom Maher | 7/1/2010 - 11:10am
This is a wonderful article that deals with very important new economic issues that have never been dealt with by American society before.

We are not all Hooverian now. And neither are we all Keynesian now as President Nixon said in 1970.

This is 2010 where the economy is substantially different from the economy of forty or eighty years ago. Different economies over time require different policies to be effective in imporving the economy.

A farm economy of 100 years ago where over 90% of people worked on farms or agriculturally related industry would require different economic policy than the heavily industrial era of the 1930s only 30 years later where overwhelingly most people worked in smokestack industries. (This super-industrial smokestack economy is still the ideal economy in most people's minds. But this economy has not existed for at least fifty years.) For at least forty years, most people work in "services".

So the economy has "structurally changed", as economist would say, very significatly at least every twenty years.

We are now in a "global economy" meaning markets are not local or even national anymore they are global. - worldwide. Nobody legislated globalization of markets. Rather global markets were chosen one transaction at a time because better valued products, services and investments could found in a global economy. Often very valuable and useful products, service and investments could only be found from foreign sources. The world has become one big market for most economic transactions including investments.

So since the early 1980s the United States government finances its debt significantly from foreign investors and banks. It has to have foreign investors because the debt is so high - trillions of dollars - that American investors and banks could not finance the debt alone. Since the mid 1980s a majority of United Stattes government and private debt is finaced by forreign banks and investors.

So majority foreign investment has become a very important "structual change" in our economy with hugh implications on U.S. economic policy. The old Keynesian theory does not deal with the need and implications of foreign investors. But as Greece near-bankruptcy demonstates, foreign investors are a hugly significant force at work in finacing national debt. Investors have refuseed to lend Greece more money to finace its hugh debt becasue investors believe Greece may not be able to pay back the debt with interest. Debt finacing is limited to a nation's ability to pay the debt back as precieved by the foreign investor.

China alone ownes almost a trillion dollars of the U.S. government debt out of 13 trillion dollar debt. China has already complained over a year ago that the U.S. has too much debt and China said they would not buy as much U.S. debt in the future. How many other foreign investors have the same worries as China? The implication is clear that foreign investor are far more cautious than native politicans about the amount of indebteness a nation can handle.

Acccordindly the old deficit-spending tricks to improve the economy risks losing investors willing to continue to lend to a country. The European Union countries at the G-20 meeting all wanted goverenment indebtedness reduced drastically. This concern over national debt can not be ignored.

One has to belive ones eyes that Greece and the five other European countries near bankruptcy over their indebtedness is a economic horror that the United States must be certin does not happen to the U.S. economy. Congress is correct to limit U.S. indebteness which is projected to grow to 20 trillion in the next five years. Allowing continued national indebtedness is very dangerous policy in a global economy that risk the loss of investors confidence in U.S. government ability to service the hugh and growing national debt.
ed gleason | 7/1/2010 - 10:57am
''why war spending in World War II brought prosperity ''
As a teenager in WWII,  I immediately experienced prosperity. I say that millions, mostly women  were put to work building 'junk'.. I say junk in that the munitions. ships, tanks, artillery, planes, military barracks etc. all were useless after August 1945. [I remember seeing a movie of miles of 105 howitzers lined up in an Az.desert  storage ground]. The greatest make work project in the history of the world since the pyramids [also in the desert.]Do Economists have an answer why building junk leads to prosperity? it sure seems to be what happens.. and its is financed by debt. Talking about junk in the desert.... ever look at housing in Nevada??!!
Anonymous | 7/1/2010 - 9:50am
''why war spending in World War II brought prosperity ''
 
World War II did not bring prosperity to anyone.  There was food on the table and not much else except for a little entertainment at the movies and a couple bucks for clothes.  Gasoline was rationed and so were tires and some foods were hard to get.  Everyone had a job and was paid something but it was not much.  I believe there was a war time tax of 100% on any income above $25,000 so few were getting rich though I assume some were able to profit.  Prosperity came after the war.
 
Economics is based on human behavior and there still is much mystery in human behavior but there is lots of data showing how people generally behave when faced with economic options.  For example, if someone comes up to you and gives you something for nothing, them most people take it.  That is what happened in the housing crisis which is the cause of our current problems.  Unfortunately there was a negative for this free money that they did not foresee, falling housing prices.  Such things happen in the physical sciences all the time but not as frequently.
Stanley Kopacz | 7/1/2010 - 8:30am
The question remains, at least for me, why war spending in World War II brought prosperity while the two wars we are waging now aren't working at all?  The 1.5 gigabucks that Mr. Cosgrove cites as being sat upon by US business is probably dwarfed by the overt spending and hidden costs of these wars and it doesn't seem to be stimulating the economy.  Wars ARE government spending and very wasteful and inefficient government spending, at that.  Consider the amounts of money lost to corruption when trying to rebuild countries like Afghanistan and Iraq where corruption is a cultural norm.
I guess my problem is that I've been a practitioner of the physical sciences.  Economics, when I really look at it, seems to be a subbranch of abberrant psychology.  Why does a piece of paper with a dead president's picture  have any value?  It is not backed by any physical material like gold or silver anymore.  Why is a dollar worth several yuan?  Why can China purposely set the exchange rate while we must allow the dollar to float?  I suppose anything is possible when you are setting up a game with arbitrary rules, unlike the laws of physics and chemistry.  But then, if the rules are so arbitrary, why can't you set them up as easily to benefit the broader populace and provide useful employment to people adding value to natural resources?
 
 
Anonymous | 6/30/2010 - 9:29pm
There are a lot of things to discuss.
 
First, the depression didn't end till 1946 (Roosevelt was scared to death of 11 million men coming home with no jobs for them.)  Nothing Roosevelt did up to WWII helped economically.  He did keep the confidence of the people and for that we should be very grateful but none of his programs worked.  After the war, both Democrats and Republicans threw out FDR's programs, cut taxes and sent the returning GI's to school.  The economy responded.  Another reason the economy worked after WWII was that most of the manufacturing infrastructure in Europe and Asia was destroyed and the US was left with most of the manufacturing capacity in the world.
 
Keynesian economics is two fold and Obama did neither.  One way of stimulating the economy is for the government to spend money on new projects, hopefully ones that will facilitate the hiring of additional people by the private sector.  Thus, investing in infrastructure would be a good way to grease the skids for business and in the 1930's a good sum of the money was spent that way on roads, bridges and dams.  That is not what happened in the last year nor was it really needed.  Business is not being held back by poor infrastructure.  The second way of stimulating the economy through Keynesian methods is to provide tax relief, for business, investors or consumers.  This form of Keynesian economics has an excellent track record of success while government spending has a poor track record.  There were some token tax cuts in the stimulus bill but they were at best token and had no effect.
 
What Obama essentially did was transfer money to the states so that they could pay their constituencies.  The whole ''shovel ready'' thing was a joke.  There was about $15-$20 left over from the highways bill in 2005 that hadn't been spent so there was no back log of projects to spend money on.  There was no stimulus, just essentially transfer of payments made to state employees and medical funds.  And all these people were already employed and most cut back on their spending because they were scared.  The lack of these transfers this year is why you are hearing the states complaining loudly because there will be a lot less federal money this year for their budgets.  The states and municipalities are bloated.
 
The main thing that caused the great depression was the contraction of the money supply and high tax rates and the insistence that government work be done by unions.  This made the work very expensive and cut down the number of people business could hire.  Today the interest rates are almost at zero so that is not a problem.  The only thing keeping the ship afloat are these low interest rates but they are not encouraging businesses to hire.
 
Today as in the 1930's there is a fear factor running through business.  The future is unknown and that can be directly attributable to Obama's policies.  Business is not going to hire unless they know that each hire will generate a profit for them.  Right now the cost of future hires is a big unknown as well as other costs and regulations.  Business is sitting on nearly a trillion and half dollars in cash their coffers and they are not spending it on expansion or new hires till they know the future.  They will probably move it over seas if the government makes it too stifling to expand here.
 
we vnornm | 6/30/2010 - 2:39pm
What unpredictable times! Many in my area go to Walmart now; sadly, many smaller stores right in the community are going out of business. So this frugality ends up working against the community.
 
It's going to be hard to change the views of people who got in over their heads on houses, lived a lifestyle beyond their means, or lost $$$ in stocks. They're not going to want to stimulate the economy with their own money. Stocks are vacillating like crazy, some bonds are acting like stocks.
 
College students are greatly stimulating the economy, and I have seen loans of over 50K for undergrads, 100 K for grads....but this kind of debt means indentured servitude later on.
 
Lots of Catch-22s. And lots of unknowns, like future terrorist attacks. This is not my field, but today's blog is a good explanation of economics for those of us who are non-specialists. This perhaps may be the most important issue of the day. tx, kevin.