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Budget Cuts?

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As violent protests erupted outside, the leaders of the world’s largest economies plotted the future course of the global economy at this weekend’s G20 summit.  So what was decided?  Well, according to various reports in the mainstream media, it was the “deficit hawks” who got their way.  Apparently the consensus of the G20 meetings was that a round of tough budget cuts is the medicine that the world economy needs.  In fact, the G20 leaders all pledged to cut their respective budget deficits in half by 2013.  Canadian Prime Minister Stephen Harper, one of the key advocates of budget cuts, said that the G20 nations need to walk a “tightrope” between stimulating their economies and debt reduction.  But as the largest economies around the globe transition from reckless government spending to budget reductions and austerity measures, what is that really going to mean for the world economy?

Well, the truth is that as good as “budget cuts” sound, they can have some very nasty short-term side effects.

You see, there is no getting around the fact that whenever governments spend more money it is good for economic growth.  The problem is that a large number of governments around the globe have been consistently spending way beyond their means for decades and now they find themselves up to their eyeballs in debt.

The exploding sovereign debt levels around the globe are not sustainable by any definition, and so it was undeniable that something had to be done.

In fact, European Commission President José Manuel Barroso put it quite succinctly during the G20 meetings in Toronto when he told the press the following….

“There is no more room for deficit spending.”

The reality is that nations such as Greece, Spain, Portugal and Italy are already on the verge of default.  Japan has accumulated so much debt that it makes headlines almost constantly in the newspapers over there.  The exploding U.K. debt was one of the key factors that enabled the Conservatives to take power in the most recent election.

But nobody has more debt than the United States.  As of June 1st, the U.S. National Debt was $13,050,826,460,886.97.  The U.S. government has accumulated the most colossal mountain of debt the world has ever seen and it is exploding at a rate that is breathtaking.

So, yes, the largest economies of the world have a major problem with government debt.

But are budget cuts and austerity measures the correct solution?

It depends who you ask.

The reality is that the U.S., the U.K. and many of the other most powerful economies in the world now find themselves between a rock and a hard place.

If they continue recklessly going into debt their economies will continue to be stimulated (at least to some degree), but interest expenses will continue to spiral upwards and borrowing costs will go through the roof as credit ratings fall.  In the end, nation after nation would end up defaulting and the world financial system would crash hard.

However, if the G20 nations actually do implement the hard budget cuts that are necessary to get their debts under control, it will suck a ton of money out of the system and could send the already vulnerable global economy into a devastating deflationary depression.

The truth is that neither option is a good option.

Either path is going to contain a good amount of economic pain.

So what do you do when there is no good solution?

Stephen Lewis of Monument Securities recently argued that the path of “fiscal stimulus” has been totally played out and so there is no good reason to continue to go down that path….

“Growth could be negative again as soon as the fourth quarter. There is no easy way out since fiscal stimulus has already been pushed as far as it can credibly go without endangering US credit-worthiness.”

However, Chris Whalen, a former Federal Reserve official and now head of Institutional Risk Analytics says that unless the printing presses are quickly cranked up again we are definitely headed for deflation….

“The party is over from fiscal support. These hard-money men are fighting the last war: they don’t recognise that money velocity has slowed and we are going into deflation. The only default option left is to crank up the printing presses again.”

So what is the right answer?

For now, G20 leaders have decided that budget cuts and austerity measures are the right answer.

Not that Barack Obama and U.S. Federal Reserve chairman Ben Bernanke didn’t fight behind the scenes for additional “stimulus” for the world economy.

You see, when it comes to “Helicopter Ben”, his first instinct is to always pump more money into the economy.  In fact, according to one major U.K. newspaper, U.S. Federal Reserve chairman Ben Bernanke has been fighting an intense behind the scenes war for control of U.S. monetary policy.  Bernanke is reportedly frightened that the U.S. could be headed for a deflationary spiral and has been pushing the idea of a fresh injection of money into the U.S. economy.

But for now Bernanke has lost.  Barack Obama has joined the other leaders of the G20 in promising to cut their budget deficits by 50 percent by 2013.

Not that we are actually going to see that happen.

We all know how reliable Barack Obama’s promises are.  He was busy breaking his 2008 campaign promises before he was even sworn in.

And the day will come when Barack Obama needs to turn the economy around in order to win some votes, and when that day arrives the temptation to “stimulate” the economy with some more government spending will prove irresistible.

But for the moment, Obama is lining up with the other G20 leaders and is swearing that he is going to get spending under control.

That should settle world financial markets down for the moment, but the reality is that as all of the major economies around the world suddenly see a dramatic reduction in government spending, a substantial economic slowdown will be inevitable.

When the world economy slows down, unemployment will spike, the global real estate mess will get even worse and “austerity riots” could even break out in many areas of the globe.

So at some point, the pendulum will once again swing back towards “stimulus” and world leaders will indulge their debt addictions once again.  But that will only make the long-term global economic problems even worse.

The truth is that the entire world economic system is broken.  It is built on a fraudulent pyramid of debt, derivatives, central banking and paper money that is doomed to fail.  But world leaders will continue to keep it alive for as long as they can.

Right now their big solution is to get all of the major industrialized nations to agree to huge budget cuts.  These budget cuts, if they are actually implemented, are very likely to lead to a severe economic slowdown and potentially even a deflationary depression.

But continuing on the path that the G20 leaders were on would have resulted in a wave of sovereign defaults and hyperinflationary meltdowns.

So the G20 leaders have decided to change course and they are hoping that they can navigate the economic minefield ahead and bring our economies through all of this okay.

But in the end they are going to fail.

  • Gringo in Brazil

    I find it interesting that the goal is a 50% reduction in the budget DEFICIT. Shouldn’t the goal be to balance the budget. If our leaders are only able to overspend our budget by $700B instead of $1.4T, should we be congratulating them? Five years ago, the country would have been outraged if they were told they were going to have a deficit of $700B. That is our spouse wanting us to be happy because he/she only put $1,000 on the credit card at the shopping mall instead of $2,000 like she used to. If we can only hope to reach a 50% reduction in deficit spending, it is quite obvious the current leaders never expect to actually pay down the debt. At this point in the game our goal should not even be focused on how to break even, it should be on how to create a surplus so that we can start paying what we owe and dig out of this hole.

  • There’s an excellent analysis at The Automatic Earth.

  • Matt

    By this time next week the G20 will have all found excuses to get out of these budget reductions and it will be back to business as usual. In the war between deflation and inflation, inflation will win – gauranteed. You can bet on it.

  • Max

    On an absolute level, the US certainly has the most debt in the world. However, there are two mitigating factors. First, the debt we have run up is denominated in our own currency, which means we can print our way out of it if we want to. Second, relative to GDP, our debt levels are less than those of other industrialized countries.

    Finally, I would point out that a bigger problem than our national debt is the underfunded Medicare and Social Security programs, which represent the real long term problem: too many promises made and nowhere near the money saved or invested to meet those promises.

  • Max

    One final point: austerity measures will certainly lead to a powerful bout of deflation, the absolute worst thing that can happen in an environment where everyone, whether it be the government, companies, or individuals, are up to their ears in debt.

    Austerity riots are likely, but without mainstream media attention, the government’s heavy handedness will go unreported, and thus, no one will care or do anything about it.

  • bob

    Its funny that obama said in his g20 speech he was going to spend his way out of this mess. Hmm, reminds me of the Japanese and their mess in the 80’s. They still havent recovered fully. They have a very big homeless problem, high rates of unemployed, end of life time employment with companies, higher suicide rates, just a messed up time thats coming to us down the road.

  • Grumpy

    I would disagree that spending stimulates the economy. While it does provide some minor relief to government employees and pet (pork) projects, temporarily increasing GDP, the fact remains that GDP is a false metric for the health of an economy; GDP includes government spending. Measured without spending, the economy has been contracting at some -2.5% per quarter for the last six quarters. All that government spending has done is to mask the true state of the economy, provided congress with slush funds, and push the social(ist) agenda of those in power. It has temporarily delayed (and made worse by an order of magnitude) the inevitable crash that is coming, and lengthened the recovery time to decades instead of 2-3 years, if any recovery is indeed possible.

    Benron,, and the Big Six on Wall Street have learned nothing from their ‘study’ of the Great Depression – they’re using the same playbook consisting of a single maneuver. And we can count on Obama to do exactly the opposite of what he says he’ll do, as he has proven every time he opens his mouth. Get ready for QEII, more of the Extend and Pretend economy, and more statistics that are totally divorced from reality.

  • Max writes: “First, the debt we have run up is denominated in our own currency, which means we can print our way out of it if we want to.”

    I don’t think you understand the relationship between printing money and debt. They’re the same thing. Every dollar printed by Ben and the Boyz at the Fed is another dollar the U.S. goes into debt. The line atop the front of every dollar bill doesn’t read, “U.S. Reserve Note.”

  • lostinmissouri

    “But in the end they are going to fail.”

    This is the scary part… I agree, it’s too late to fix it. Americans should brace themselves for what is coming.
    Everyone should be making some sort of survival plans.
    This is not going to end pretty.

  • sharonsj

    We already have deflation, if you mean it in economic terms: a contraction of credit and money. Banks aren’t loaning and the credit card companies are getting rid of customers while lowering how much they can charge.

    But if you’re talking about deflation in consumer prices, there isn’t much of that except for clothing and some supermarket sales. Everything else has gone up in price, especially energy costs.

    Meanwhile, any talk of cutting deficits means they will be fucking over the poor and middle class–you never see them lowering their own salaries, or stopping the government from giving lucrative expensive contracts to their friends, or not starting unnecessary wars, or saying no to the corporations destroying America.

    Finally, Congress has been leasing our vast resources to companies like BP for pennies. The oil and gas companies make billions by selling our resources to the res of the world. Did you really think that BP is under orders to sell American oil to America?

    I hold out no hope for the future. Time to hunker down and reload.

  • bluestone

    I don’t believe that Europe will cut spending. I think they’re just talking a good talk, and even the talk isn’t that good. By 2013? Too little, too late.

  • Max

    In response to Guy McPherson:

    Perhaps I don’t understand the meaning between debt and money, but I know one thing: The Federal Reserve can monetize our federal debt anytime it wants to.

    Furthermore, and more interestingly, has anyone ever thought that our currency is basically a piece of paper (fiat currency) that we exchange with other countries for ACTUAL goods and services? These other countries then loan us the money at interest rates that we set (via the Federal Reserve). It is an outstanding scam, and we’ve been doing it since WWII. The only reason other countries accept this situation is because we have the power to blow them off the planet.

    I would also like to point out that the Congress of our country delegated the right to coin money and set its value to the Federal Reserve (a private entity), and it can just as easily take that away.

    At the core, the debt that our government creates is not an economic problem, but a political one, and politics can be used to solve the problem.

    Please consider the following solution, however simplistic and politically unrealistic:

    Congress passes a law abolishing the Federal Reserve, taking back the right to coin money and regulate the value thereof.

    Federal Reserve Notes are exchanged for US Notes at a value of $1 US Note = $10 Federal Reserve Note.

    Congress then prints up a batch of $1 trillion of the new US Notes, spends that money on new infrastructure (new airports, high speed rail, better freeways, new power grid, nuclear power plants) and indicates that taxes can only be paid in US Notes.

    When treasury debts come due, print up a batch of US Notes and pay them off.

    There will certainly be some inflation at the onset no doubt, but we’ll get out of this mess that we are in, no doubt about that.

    Abraham Lincoln printed greenbacks to fund the initial effort of the Civil War. These greenbacks had nothing backing them except the will of the government and the fact that taxes had to be paid using this scrip. It worked.

    Why should it be that banks get to determine how much credit is created via the process of making loans? Money and credit belong to all of us, as the Constitution clearly guides, when the Founding Fathers of this nation gave Congress the authority to coin money and regulate the value thereof.

  • haarp

    Max wrote: “Why should it be that banks get to determine how much credit is created via the process of making loans? Money and credit belong to all of us, as the Constitution clearly guides, when the Founding Fathers of this nation gave Congress the authority to coin money and regulate the value thereof.”

    Hi, Max. Just a quick bit of advice. If you haven’t already read it (though I suspect you probably have), I would highly recommend a book called The Creature From Jekyll Island by G Edward Griffin. In fact I would definitely recommend this book to everyone reading this because if you are reading this then you already have some interest in the subject matter of the book.

  • Professor G

    President Obama is not an economist; he really does not understand economics. His Keynesian lackeys are firmly committed to printing more money.

    Political scientist Theodore Lowi wrote a book called The End of Liberalism back in 1979. I think it was updated in the 1990s, that explains why President Obama will not implement anything austere. The states are another story; they do not have a choice.

    Another excellent read is David Mandelbaum’s The Case for Goliath. This explains the geopolitical position of the U.S. today and helps to clarify why policymakers continue to push what appears to be Keynesian Madness. The main ideal of the book is not directed towards explaining this, but you can infer it rather easily.

  • Professor G

    Germany will cut spending; political culture and history (memory regimes) do matter. Institutions (rules of the game) are also integral. Germans are tough and can handle it. They have a powerful productive capacity whose roots are to be found in the late 19th century and in their education/training. They have the ability to ramp up their productive capacities when they need to. Japan has the same two factors, remarkably similar countries!

    The U.S. is a different story. My guess is that the U.S. is a toss up. I think our political culture has undergone a transformation post-World War II. We are a lot like Great Britain/U.K. at the beginning of the 20th century. We think we are too important and to big to fail. As a political economist and international relations professor, I say the U.S. is failing.

    We need to consolidate by ending our campaigns in Afghanistan and Iraq. I think we have greatly exaggerated the number of soldiers, marines, etc. needed in Afghanistan. Trying to control the entire country and root out corruption is lunacy. We went to Afghanistan out of honour. The goal should be to kill OBL and his munchkins period. Now we are protecting Karzai and trying to prevent another post 1975 Vietnam and Cambodia.

    We need to be serious about education. As a professor, I will tell you the honest truth. American students are the most ignorant and least educated students on the planet. I know you hear that a lot, but it is true. We are facilitating a two tiered system where the only students who get a decent education are the geniuses and the ones who can afford a private one. I have lots of ideas that can work as I am sure many of you have as well. The bottom line is we must get serious about this. It starts with the parents. Parents today tend to overprotect their children. I used to see this a lot when I taught in third world countries; years ago I gave U.S. students credit for being more mature in some ways than students in LDCs.

  • “But in the end they are going to fail.”

    What a great line. It’s great because 1) it made me laugh and 2) it’s true.

    There is nothing that can prevent the economic pain that’s about to hit America. The only question is, “What kind of economic pain will it be?”


  • Luke Scarlett

    Re Max’s comments:
    Read Ellen Brown’s “The Web of Debt”_a brilliant analysis of the corrupt banking system based on the historical record.
    He’s right, you can monetize the debt and start again without inflation.

  • EvilBuzzard

    I think that as long as anyone has money in any bank at all, there is no excuse for a Federal Budget cut. We take the money back. We give it to the people. Never mind if the people graduated from Dartmouth last year and won’t condescend to taking a job that only pays them $40K per year because it isn’t worthy of their talents….Never mind if over half of the people pay no net income tax. Anyone with any possessions must have them nationalized!!! The Budgets cannot be cut.

  • Sam

    “But in the end they are going to fail.”

    SJ : you’re askind what kind of economic pain? It would rather will be worst than the gentlemen in the queue’s in those 30’s.We need to queue for the baggets (without any butter or cheese).
    “But in the end they are going to fail.” 🙁

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