Get Ready To Taste The Bitter Side Of Keynesian Economics

Most Americans have no idea what the term “Keynesian economics” means, but the truth is that it has been deeply influencing U.S. economic policy for decades.  Essentially, it is an economic theory that originated with a 20th century British economist named John Maynard Keynes, and it advocates government intervention in the economy in order to smooth out economic cycles.  The general idea was that lower interest rates and increased government spending could be used to increase aggregate demand when the economy was experiencing a downturn, thus increasing economic activity and reducing unemployment.

And you know what?

To a certain degree, Keynesian economic theory actually does work.

Increased government spending DOES stimulate the economy.

But the problem is that governments all over the world decided that they would just run constant budget deficits and stimulate the economy all the time.

All of this debt has brought a temporary prosperity to many of the nations around the globe, but there is one huge problem with debt.

It has to be paid back eventually.

With interest.

So what happens when nations have to start spending huge chunks of their national budgets just to service all the debt that they have piled up?

Well, that is when they taste the bitter side of Keynesian economics.

In fact, we see that starting to happen all over the world right now.

All of a sudden, governments all over the globe are talking about huge budget cuts, pay decreases, and higher taxes.

We all know about what is going on in Greece right now, but suddenly it seems like “austerity measures” are being implemented all over the place.  Just consider the following examples….

*Portugal has pledged to impose fresh austerity measures that include much higher taxes and dramatic budget cuts.

*Barack Obama is personally pressuring Spain to make severe austerity cuts.

*It’s not just Southern Europe that is facing these austerity measures either.  It is being reported that Germans are bracing themselves for a “bitter” round of budget cuts.

*The exploding debt situation in the U.K.was a major issue in the most recent election.  Bank of England governor Mervyn King has even gone so far as to warn that public anger over the “austerity measures” that soon must be implemented in the U.K. will be so painful that whichever party is seen as responsible will be out of power for a generation.

*Federal Reserve Chairman Ben Bernanke says that United States citizens will soon have to make difficult choices between higher taxes and reduced government spending.

*California Governor Arnold Schwarzenegger is reportedly planning to seek “terrible cuts” to eliminate an $18.6 billion budget deficit facing the most-populous U.S. state through June 2011.

*In fact, many U.S. states are getting ready for their biggest budget cuts in decades.

Austerity measures for everyone?

That is the way it is shaping up.

So what happens when austerity measures are implemented?

Well, just as Keynesian economics correctly predicts that economic growth goes up when government spending increases, it also correctly tells us that economic growth goes down when government spending decreases.

So all of these austerity measures are going to mean economic pain for a whole lot of people.

Not only that, but there are now whispers that this European debt crisis could potentially cause the break up of the euro.

Whether or not that is actually the case, officials in Europe are sure seizing on this crisis to advocate for increased centralization of power in the EU.

For example, senior administrators of the European Union are proposing that they be given unprecedented power to scrutinize the spending plans of member countries before national parliaments can vote on those budgets.

Talk about a loss of sovereignty.

But not only that, the Governor of the Bank of England, Mervyn King, has come right out and said that he believes that the European Union must become a federalized fiscal union if it is to survive.

Doesn’t it seem like whenever there is a crisis the solution that is always being proposed is to give centralized institutions even more power?

There has also been talk that nations such as Greece could end up being ejected from the euro, but the reality is that such a scenario is not very likely.

For one thing, the ECB has already come out and said that under current EU law, ejection of a nation from the monetary union is “legally next to impossible”.

In addition, leaders throughout Europe realize that if the euro fails then the entire EU may fail as well.  German Chancellor Angela Merkel made this very clear when she recently warned that if the euro collapses, “then Europe and the idea of European union will fail.”

For many in Europe that would seem like a disaster, but the truth is that it would be a wonderful, wonderful thing if the euro failed.

Why?

Because it would represent a major defeat for those who are seeking to drag us towards a “world currency” and a “global government”.

It would also be a huge victory for those who still believe in national sovereignty and the decentralization of economic power.

So let us hope that the euro breaks up.

But don’t count on it.

Meanwhile, the one thing that we can count on is all of the economic pain that all of these new austerity measures are going to bring.

Will The U.K. Be The Next European Nation To Experience A Massive Debt Crisis?

Now that the Greek debt crisis has been “fixed” by a gigantic pile of more debt, many are wondering which European nation will be next to experience a massive debt crisis.  Increasingly, all eyes are turning to the U.K. and their public debt that is spiralling out of control.  The U.K. government’s deficit is projected to be approximately 13 percent of GDP in 2010, which is even worse than Greece’s 12.5 percent figure.  Right now the public debt of the U.K. is “only” at 68 percent of GDP, but three years ago it was sitting at about 40 percent, so as you can see the national debt of the U.K. is absolutely exploding in size.  In fact, it is now being projected that the public debt of the U.K. will exceed 100 percent of GDP within the next three years.  Considering the fact that citizens of the U.K. are some of the most highly taxed people in the world already, there just is not much room for raising more revenue.

So obviously there is a problem.

A massive, unchecked, out of control problem that threatens to blow out the entire U.K. economy.

And considering the fact that it took just about everything that Europe could muster to bail out poor little Greece, how in the world is Europe going to be able to bail out the U.K. when their debt crisis violently erupts?

If Greece almost brought down the euro and the financial system of Europe, then what would a financial implosion in the U.K. do?

Considering the fact that the Greek economy is approximately 16% the size of the U.K. economy, it is very sobering to think what a “Greek style” debt crisis in the U.K. would mean for the entire world.

But if something is not done rapidly it will happen.

Just consider the following charts….

Now how in the world do you go from a deficit that is between 2 and 3 percent of GDP in 2007 to one that is above 11 percent in 2009?  That takes some serious financial mismanagement.  Not only that, but as we mentioned earlier, this year the deficit is projected to be approximately 13 percent of GDP.  That is a level that is catastrophic.

Kornelius Purps, the fixed income director of Europe’s second largest bank is very open about the fact that he believes that the U.K. is likely the next European nation that will face a very serious debt crisis….

“Britain’s AAA-rating is highly at risk. The budget deficit is huge at 13% of GDP and investors are not happy. The outgoing government is inactive due to the election. There will have to be absolute cuts in public salaries or pay, but nobody is talking about that.”

In fact, Morgan Stanley has already warned that there is a very strong probability that some of the rating agencies may remove the U.K.’s AAA status before 2010 is over.

If that happened, it would make the crisis that we just saw in Greece look like a Sunday picnic.

So what must be done?

Well, already world financial authorities are calling for “austerity measures” and deep budget cuts to be implemented in the U.K., but the reality is that those moves will cause deep economic pain.

In fact, Bank of England governor Mervyn King recently warned that public anger over the “austerity measures” that soon must be implemented in the U.K. will be so painful that whichever party is seen as responsible will be out of power for a generation.

The cold, hard reality is that the U.K. is in for economic pain in any event.  Either they cut the budget and implement severe “austerity measures” which will hit people really hard economically, or they continue on the current course and risk a much worse version of what just happened in Greece.

Not that the rest of the world should be gloating about what is going on in the U.K. either.

The financial situation in Japan is even worse than what the U.K. is dealing with, and the United States is going to have the biggest economic downfall of them all one of these days.

As we wrote about yesterday, the sad truth is that the governments of the world are rapidly running out of money and are drowning in debt.  It is a gigantic mess, and the term “sovereign debt crisis” is going to pop up in the news very regularly from now on.

You see, it is not just the financial systems of the U.S. and the U.K. that are broken.  The entire world financial system is fundamentally flawed and is doomed to failure.

Right now the central banks of the world can do their best to try to hold things together with a tsunami of debt and paper money, but they are not going to be able to keep up this balancing act forever.

When it does all start coming apart and the dominoes do start falling, it is going to be a complete and total nightmare.  Paper currencies around the globe will lose value at breathtaking speeds as central banks flood economies with cash in an attempt to stop the madness.

But more debt and more paper never solves anything.  All it does is make the long-term problems even worse.

When the tipping point comes, things are going to move fast.  Let’s just hope that we all have a good bit more time to prepare before that happens.

The Juice Lady