Posts Tagged ‘1932’

‘The market is rational and the government is dumb’

3 August 2011

The above quote is a favorite of former House Speaker Dick Armey (R-TX). He even used to write it on the blackboard on the first day of class when he was an economics professor. Armey has been out of government for years, but as a founding member of a Tea Party group, he’s been a big influence on that wing of the Republican Party. Not surprisingly, he seems pleased with the pounds of flesh they’ve extracted in the new Budget Control Act of 2011.

Armey and I have different ideas of “dumb.” He favors slashing government spending during our Little Depression and also favors a balanced budget amendment that would supposedly compel further slashing. I think those things are time-tested recipes (the times being 1932 and 1937) for worsening a depression. What do the markets think?

The stock market is on track for its eighth straight day of decline (as of 11:55 a.m., the S&P 500 is down 0.5%, and its biggest drop, 2.6%, was yesterday, when the Budget Control Act finally passed). 10-year Treasury bond prices have been rising, and T-bond interest rates falling, over the same span, now down to 2.57%. How to interpret those numbers?

Hard to do, because nobody (as far as I know) takes scientific polls of market participants to ask them why they did what they did. Armey would probably say, as some commentators have, that stocks have tanked because the $2.1 – 2.5 trillion in cuts over a decade aren’t enough. I would say, as have others, that the market is reacting to the dismal state of the economy and to the likelihood that, as basic macroeconomic theory tells us, the spending cuts will make it even more dismal.

What about bonds? The rosy view would be that T-bond prices have improved because the debt-ceiling vote means no default through 2012 and the spending cuts reduce the overall burden of debt. Armey and I might actually agree that the unrosy view is correct: T-bonds are in higher demand because of a worldwide “flight to safety,” as grim economic news causes people to move away from risky, cyclical assets like stocks and toward safe assets like T-bonds. Again, is the grimmer news the “failure” to slash spending more or the weakening economy?

I’m thinking Armey’s quote fits right now, except it’s the budget bloodletters who are dumb and the markets are rationally reacting by anticipating that they will cause further hemorrhaging of the economy.

P.S. At least one market participant agrees. From the Aug. 2 Financial Times:

‘Jim Reid, strategist at Deutsche Bank, . . . has warned the US could be approaching a “1937 moment” – when authorities removed post-Depression stimuli from still-fragile markets and triggered another recession. This risk, he says, has in fact only been magnified in the markets’ eyes by agreement on raising the US debt ceiling.’

(Hat tip: Brad DeLong)

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Feeling 1932 (updated, Aug. 1)

28 July 2011

I’ve written already that the best deal on the debt ceiling would simply be to raise it (or better still, abolish it), without attaching it to a bill that punishes the economy further by slashing spending and/or raising taxes. The last thing this ailing economy needs is a Grand Bargain to reduce the current deficit. It was disastrous policy during the Great Depression — first by Congress and President Hoover in 1932, then by Congress and President Roosevelt in 1937. I would have thought those historic blunders would not be repeated, but I guess it’s always a mistake to assume that politicians know economics or history. But I’ve said all that before.

What I want to point out here is that we’re due for some ill-timed spending cuts (and maybe tax increases), regardless of what Congress does in the next week. Remember that $787 billion stimulus package that Congress passed in early 2009? It was spread out over two years, so roughly $400 billion a year, about $250 billion of which was spending and $150 billion tax cuts, almost all in 2009-2011. So that stimulus is just about “spent.” The main tax cuts, like extending the patch for the alternative minimum tax, will probably be maintained because they’re politically popular, but the spending almost surely will not. So that’s an abrupt drop of about $250 billion in government spending, or about 2% of GDP, over the next year. This chart from James Fallows’ blog for The Atlantic shows the projected big drop in fiscal stimulus from “Relief measures.” That’s the trouble with stimulus — it’s finite. Congress passes these things reluctantly, and if the economy still needs stimulating when it’s over, people are more likely to conclude that it failed rather than that it was too small (which it was) or that it spared us even worse devastation (which it did).

Now it is possible, perhaps even probable, that Congress will fail to pass any deficit-reduction deal and will end up raising the debt ceiling anyway — after all, that’s what’s happened virtually every previous time that a debt-ceiling vote has come up. But even if Congress ends up not inflicting any new wounds on the economy, we’re looking at big-time deficit reduction that will do plenty of damage on its own.

UPDATE, 1 Aug. 2011: Actually, it looks like it’s already happened. In the dismal GDP figures released last week, the government’s contribution to real GDP growth was negative 1.2 percentage points in the first quarter of 2011, with about two-thirds of the decline coming from the federal government. Government purchases account for about 20% of GDP, so cuts in government purchases reduce GDP. “Fiscal drag,” the economists call it. Federal government purchases fell 9.4% in the first quarter (the unwinding of the stimulus surely had much to do with this), and state and local government purchases fell 3.4%. (In the second quarter federal purchases rose 2.2% and state and local purchases again fell 3.4%.)

P.S. The title’s musical inspiration is forty years off and I’ve used it before, but hey, it’s a good song.