Generational Dynamics: Forecasting America's Destiny Generational
 Forecasting America's Destiny ... and the World's


Generational Dynamics Web Log for 1-Apr-2009
Fiscal stimulus programs in 1930s and today

Web Log - April, 2009

Fiscal stimulus programs in 1930s and today

Did Hitler really do everything right?

The US government has spent, lent or committed $12.8 trillion, for bailouts and stimulus spending, according to the latest figures.

It wasn't that long ago that a billion dollars seemed like a lot of money. But then we had President Bush's $60 billion stimulus package, followed by various bailouts and fiscal stimulus packages costing almost a trillion dollars each, and a new multi-trillion dollar budget.

Related Articles

Fiscal stimulus
The current stock market bubble correlates with bailouts and stimulus: This is another refutation of Richard Koo's stimulus theories.... (14-Oct-2009)
Fiscal stimulus programs in 1930s and today: Did Hitler really do everything right?... (1-Apr-2009)
The effects of massive fiscal stimulus - Part II: President-elect Barack Obama is turning apocalyptic in his speeches.... (12-Jan-2009)
The economic outlook for 2009 : How we got to where we are today, who's to blame, and where we're going in 2009. (5-Jan-2009)
The effects of massive fiscal stimulus.: A study comparing Japan's deflationary spiral with ours shows the way.... (24-Dec-2008)
One, Two, Three ... Infinity: Watching the world spin out of control.... (25-Nov-2008)

Are we going in the right direction?

In articles in December and January, "The effects of massive fiscal stimulus," and "The effects of massive fiscal stimulus - Part II," I described a presentation that was the first thing I'd heard in years that forced me to reassess my thinking about the country's continually exponentially escalating public debt. The presentation, by Richard C. Koo, Chief Economist at Nomura Research Institute, drew on the experience of the 1930s Great Depression and the 1990-2005 "lost decade" in Japan to reach the conclusion that these massive spending programs are exactly the way to go.

Still, Koo's presentation raised some serious issues and possible flaws in his theory. These issues are highly relevant to the choices being made by Congress and the Obama administration.

Last week, Koo gave a new presentation, addressing today's news, as well as some of the issues that I raised. I recommend to everyone to listen to and watch both presentations.

In this article, I'm starting with a lengthy summary of the latest presentation. Then I'll address what are apparently several flaws. And finally, I'll relate it all to the coming Clash of Civilizations world war.

Presentation summary

Here are the major points that Koo covered in his presentation:

I'll now turn to some major issues and possible flaws in Koo's theory. I've discussed these issues before. In this presentation, Koo addressed some of these issues, but did not give satisfactory answers, in my opinion.

The timing problem

This is the biggest flaw in Koo's presentation and in the Obama administration's plans.

The stimulus programs that have worked in the past have all required a five-year delay before they even began to be effective.

President Herbert Hoover's administration tried various spending programs in the early 1930s, but they were ineffective. It wasn't until 1935 or so that President Franklin Roosevelt's spending programs began to be effective. A similar statement can be said of Japan in the early 1990s.

According to Koo, a balance sheet recession begins when a huge asset bubble bursts. As with an ordinary balloon, when it starts leaking it leaks very quickly at first. After a time, it's almost completely deflated, and the leaking occurs more slowly.

In other words, a deflationary spiral is very rapid at first.

According to the Bank of International Settlements, there are over $1 quadrillion ($1,000 trillion) worth (notional value) of credit derivatives and other structured finance securities in the portfolios of financial institutions around the world. That represents a good part of the credit bubble. That bubble is leaking at perhaps a trillion dollars or so per month. The leaking is very rapid right now, and no stimulus program can keep up.

That's why the bill is already up to $12.8 trillion, and growing. No amount of bailouts and stimulus can keep up with the leaking, at least not at this time.

Koo's 3-5 year estimate for the crisis to end is simply wishful thinking. It took 15 years for Japan's crisis to end, and there's no reason why it should take the US any less time, especially since it took almost 15 years for the dot-com, real estate, credit and stock market bubbles to expand.

Tax cuts versus spending

Koo's attitude towards tax cuts doesn't make sense. His point is that if you use stimulus money for tax cuts, then the businesses simply use the money to pay down debt, so you only get 1 to 1 leverage for that money. But if you use the money for government spending projects, then the money creates jobs, and in a domino effect, that money creates 8 to 1 leverage.

But he overlooks the fact that lowering business taxes will allow businesses to save jobs, and will allow some businesses to survive, where they might go out of business without the tax cut. If a business lays people off or closes completely, then there's a reverse leverage effect, possibly 8 to 1. So carefully targeted tax cuts are just as important as carefully targeted spending programs.

If a tax cut can save 5 million jobs, that's better than spending stimulus money on 3 million make-work jobs.

What I proposed last month was that stimulus spending be split into two phases: First, a Preservation Phase, where the focus is on preserving existing jobs and businesses, and then, after five years, a Recovery Phase, where spending is targeted at new jobs.

The Administration seems to understand the "Preservation Phase" concept when it comes to the automobile industry (which is unionized), but they seem unwilling to do anything to help other businesses survive.

Japan's export economy

Another big flaw is Koo's theory is his response to the issue of export markets. During Japan's balance sheet recession, the rest of the world was in a credit bubble, and Japan could export trillions of dollars worth of goods to other countries, in exchange for currency. Koo claims that exports had no effect, since Japan's trade surplus was "remarkably stable" throughout the entire period, 1990-2005.

But that's not the point. Suppose those export markets hadn't existed? Then Japan's trade surplus would have gone sharply negative, and Japan's GDP would have fallen sharply, instead of staying flat.

The issue is what I call "leakage," and I can't figure out whether Koo doesn't understand this (unlikely) or is lying about this issue.

This intersects with the issue of protectionism, a subject that Koo never mentioned. In order to prevent leakage, a country can insist that all stimulus funds be spent internally -- which the US has done with its "Buy American" clause in the stimulus plan. Protectionism invites retaliation, and ALL countries' GDPs go down, as happened in the 1930s.

In order for the stimulus money to come back to the Treasury, it has to be used internally within the country. If the money is used for foreign goods and services, then it "leaks" out of the system. The only way to compensate is to get the money back through exports, and Japan had plenty of export opportunities available.

As if proof were needed, the latest economic figures from Japan are devastating: Japan's exports plunged a record 49.4% in February, and the economy shrank at an annual 10.9% last quarter.

And as I'm typing this, a new Tankan survey of manufacturing confidence has fallen to the lowest level since the survey began in 1974.

It's really pretty clear what happened to Japan. The stimulus programs didn't really help much at all. Instead, the economy shifted to where the money was -- exporting to China and the US. Now those export markets have virtually disappeared, and Japan is going to be suffering along with everyone else.

It's also pretty clear that President Roosevelt's spending programs really didn't help much in the 1930s. What ended the Great Depression for America was World War II.

And that brings us to the most important subject of all.

Hitler and today's dictatorships

Koo's most dramatic remarks came at the very end. FDR's spending programs didn't end the 1930s Depression. World War II did. Spending on the military, according to Koo, gives the highest "bang for the buck."

Koo said Hitler did everything right -- spending massively on the military. (He would be forgiven for not mentioning that probably the Japanese did everything right as well.) He expressed the hope that this worldwide financial crisis would not allow dictatorships to get ahead of democracies.

What dictatorships is he talking about? Well, maybe Russia, but you can be sure that he's thinking of China.

A few days ago, in "New Pentagon report shows China continues to prepare for war with US," I discussed the rapid military buildup that China is pursuing.

China is now embarking on a very aggressive fiscal stimulus plan. China doesn't say how much of the stimulus is going into the military. But China has already been increasing the military budget by 10-20% a year for years, as they prepare for war with the United States. I think it's quite certain that China will take advantage of this fiscal stimulus program to further increase military spending.

In the US, by contrast, President Obama is planning to cut weapons systems. As the world becomes increasingly dangerous, the US is becoming weaker.

I don't know whether Koo intended this when he made those final remarks about Hitler, but he illuminated a fast-approaching world in which the US and the world's democracies will be stumbling forward with social programs and bridges to nowhere, while China is turning into a high-powered military machine, preparing for war.

(Comments: For reader comments, questions and discussion, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (1-Apr-2009) Permanent Link
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