By Brian Buckley
LIKE the French royal House of Bourbon, some contemporary schools of economics have learnt nothing and forgotten everything. Paul Krugman and Stephen Kirchner (BusinessDay, 19/3) provide telling examples. Their nostrums for the world debt crisis are more government spending, or greater volumes of easy credit, or both.
Professor Krugman is a great admirer of Franklin Roosevelt's New Deal, but he omits to mention that FDR never got unemployment below 14 per cent, and the unemployment figure in the US was 17.2 per cent at the start of World War II.
New Deal, what New Deal?
Like Krugman, Kirchner (and Ben Bernanke), FDR was worried about price deflation so much that he had farmers' crops burned to keep prices up. This was in the middle of the 1930s Depression when millions of families were short of food.
The artificially low interest rates promoted by former Federal Reserve Bank chairman Alan Greenspan (well below normal market rates) saw the consumption sector of the US economy grow from about 66 per cent of GDP to 72 per cent. The percentage increase may not look so great, but the cash figure represents an increase of about $US850 billion a year ($A1240 billion).
Where did this avalanche of money go? Into investment properties, new house purchases by the low or no-income sectors, commodities, sharemarkets, shiploads of Chinese durables and consumables, weird financial products and derivatives of New York and London and into the pockets of the crooks and sharpies of the investment banks and hedge funds.
The interest rates set by Greenspan, combined with government winks and nods, were an offer of free money to those in on the game. Greed was certainly a factor, but if you set up a stall offering free money, the greedy will knock down both the stall and passing pedestrians in the rush.
Asset inflation doubled, much of it financed by cheap borrowings and derivatives based on debt. The Securities and Exchange Commission and Congress looked away from huge and dishonest gearing that flourished in front of them.
The whole was compounded by a sudden increase in the Bush regime's government debt. As that mastermind of fiscal and foreign policy, vice-president Dick Cheney, said: "Deficits don't matter."
US Government interventions in the form of guarantees for the large mortgage buyers such as Fannie Mae and Freddie Mac, and legislation demanding that commercial banks lend to people with no capacity to pay poured fuel on the fiscal fire. (People could get mortgages by producing a power bill.)
Despite Washington's dismal record of government failure, we now have bank bail-outs, mortgage industry bail-outs, car industry bail-outs, and hundred of billions of dollars of President Barack Obama hand-outs to selected industry and politically sensitive target areas.
Obama's Government deficit is now estimated by Goldman Sachs to reach $US2.5 trillion this year. That is an additional $US25,000 per household on top of record US mortgage, credit card and other debt.
Official US federal debt is now approaching $US12 trillion. That is nearly $US120,000 for each household, and more than seven times national savings.
No surprise that the Chinese Prime Minister has told the world he is now worried about the effects of these subsidies, doubtful loans, and deficits on the US bond market, the dollar and world trade. It was a stark warning that China may not finance future US Government bonds and government spending.
Fed chairman Bernanke has taken the warning, promising that the Fed will now monetise large chunks of Washington's debt. This is known as doing a mini-Mozambique.
There are no easy solutions. Perhaps $US20 trillion has to be sliced out of the US debt structure. Unproductive businesses have to be let go so productive ones can grow again.
Real banks must be allowed to take the space of the zombie banks. Asset values must be allowed to reach their market price so they will become actively traded again.
Instead of wasting scarce funds on Wall Street mates, the President could divert what is left to training the unemployed.
But creating more debt and encouraging more debt-based spending is a recipe for permanent recession.
Brian Buckley is a public policy consultant.