The Communiqué of the past weekend's G20 meeting illustrates that deficit hawks have gained ascendancy in global policy making circles. Great Depression II, here we come.
"Those countries with serious fiscal challenges need to accelerate the pace of consolidation," the Communiqué noted. "We welcome the recent announcements by some countries to reduce their deficits in 2010 and strengthen their fiscal frameworks and institutions."
European Central Bank President Jean-Claude Trichet said fiscal tightening in "old industrialized economies" would aid the global economic "expansion" by shoring up investor confidence. German Chancellor Angela Merkel said Germany was poised for a "decisive" round of budget cuts that would shape government policy for years to come.
Although, the global economy has revived somewhat from its post Lehman collapse, it hardly merits Trichet's characterization of "expansion", given prevailing double-digit unemployment across the globe. And global recovery will be severely hampered if active fiscal policy support -- the kind of government stimulus required to sustain higher levels of growth and employment -- is completely abandoned, as the G20 discussions suggest. The new remedy for collapsing demand is "budget consolidation" -- a weasel term designed to mask more spending cuts in vital social services.
Notwithstanding the US Treasury's attempts to mitigate the rise of hair shirt economics, the Obama Administration has contributed to this rising type of deficit reduction fanaticism through its own policy incoherence. The President and his main economic advisors -- Timothy Geithner and Lawrence Summers -- continue to accept the deficit hawk paradigm: they agree deficits are ‘bad' in the long term. But they argue for the necessity of tax cuts and higher government spending increases in the short term, and deficit reduction later. They also embrace the principle of "sound finance" -- the type you read about every day in the papers: balancing the budget over the course of the business cycle and only increasing the money supply in line with the real rate of output growth. They ignore the more crucial consideration: namely, that the government should maintain a reasonable level of demand at all times and that principles of "sound finance" should not be divorced from economic context.
It's even worse in Europe. In Great Britain, the new Conservative-Liberal Democrat coalition is under pressure to eliminate the UK government's deficits in spite of the fact that the previous Labour Government's aggressive deployment of fiscal policy arrested the prospect of an Iceland-style economic calamity. Yet with no unintended irony, British PM David Cameron had this particular gem of an insight:
"Nothing illustrates better the total irresponsibility of the last government's approach than the fact that they kept ratcheting up unaffordable government spending even when the economy was shrinking." (Our emphasis)
So we're supposed to ratchet up government spending when the economy is growing? When it can present genuine inflationary dangers? If this is the type of policy incoherence we have in store, then God help the United Kingdom. This statement would be funny if not so unintentionally destructive. The government will most certainly uphold the promise of "decades of austerity" with economic thinking of this quality.
Meanwhile, within the rest of Europe, the so-called "PIIGS crisis" has merely further reinforced the now prevailing view that deficits are bad and destabilizing in the long term, thereby necessitating strong doses of fiscal austerity, even at the cost of more short term pain.
They are all tragically mistaken.
To get back to first principles, there is no meaning in the term "large deficit". As Bill Mitchell argues:
"The budget deficit is the difference between what the government spends and what it receives in revenue (mostly from taxation collections). We call the extra spending above taxation revenue - net public spending. It is an accounting statement only (that is, records information about the flows of spending and revenue collections) but movements in the deficit do provide information about the state of the economy... the budget balance will move toward or into deficit when the economy is weak because tax revenue is falling and welfare payments are rising." (Our emphasis)
In this circumstance, the government must increase spending (either directly or via tax cuts) to arrest the downward spiral of private spending. In basic accounting terms, government deficit spending is merely the counterpart of private sector saving. It is not some sort of financial vacuum that draws in government revenues into one big financial black hole over time. What government deficit spending does is to permit the private sector to achieve its level of desired saving. When the latter changes, government spending ought to be adjusting in the opposite direction to offset it (unless the current account balance also changes).
The level of employment is the most obvious factor which affects the private sector's tendency to save. Higher unemployment induces a bigger desire (need) for more precautionary private sector saving. The fact that there is nearly 10 per cent official unemployment in the US at present and even higher unemployment in Europe means that the governments have not helped enough to offset this higher tendency to save by generating higher levels of employment.
If the government ran budget surpluses for several years, then the private sector would have to run deficits for just as many years -- going into debt that totals trillions of dollars in order to allow the government to retire its debt. It is hard to see why households would be better off if they owed more debt, just so that the government would owe them less.
We should think of the fiscal policy as a balancing wheel where spending financed by borrowing must offset the propensity to save (and the propensity to import) out a full employment level -- as long as private sector going into debt is not sufficient. Our position is, in effect, a 21st century version of the great post-Keynesian economist, Abba Lerner's "functional finance" as opposed to the misleading and destructive "sound finance" theory. Lerner explained the way we ought to decide on fiscal policy like this: "The central idea is that government fiscal policy...shall all be undertaken with an eye only to the results of these actions on the economy and not to any established traditional doctrine about what is sound or unsound." ) Lerner's objective was to advance economic policy debate beyond what he called "sound finance" (which is the precursor to today's destructive neo-liberal thinking).
Thinking along Lerner's lines, we suggest that the primary objective of fiscal policy must be to spend on productive job creation packages. It should not be driven by crony capitalism, which directs massive financial subsidies to a few wealthy, well-connected political insiders. This has been a crucial flaw in virtually all global fiscal packages. Bond holders continue to get paid back at par, whilst the sheer magnitude of these payments is being used as an excuse to slash vital public services, pensions and other government spending.
As private spending recovers over time, the budget deficit starts to shrink automatically (via the automatic stabilisers). At some point, the government may have to cut back its discretionary net spending to avoid overall aggregate demand (the total spending in the economy) becoming excessive in relation to the capacity of the output side of the economy to produce. If demand outstrips that capacity, then we get inflation. Of course, when inflation happens, governments may choose to increase taxes to choke off some private spending. It all depends on the economic context in which these decisions are taken.
With Lerner's ideas in mind, here's what we would consider an ideal statement from the G20:
"A prosperous and sound economy is indeed one of the foundations of national security, if not the central pillar (or even the ground, for that matter) of any such foundation. Therefore, we demand that all G20 nations launch a new comprehensive employment security measure which entails a minimum or living wage job guarantee for all takers.
In Europe, we urge suspension of the self-imposed fiscal rules embodied in the Treaty of Maastricht. Furthermore, we recommend the expansion of the European Investment Bank to become the funding mechanism through which the current account surplus nations, such as Germany, can recycle their surpluses in demand deficient deficit countries within the EU, so as to generate additional employment and thereby better facilitate debt service across the euro zone.
In the US, pilot projects will be immediately authorized and put into action in Detroit and along the Gulf, preferably before a long hot summer gets too far underway. Gulf hiring will be devoted primarily to environmental restoration, including the largest scale roll out of Army Core engineers ever contemplated in civilian history to mitigate the emerging ecological disaster approaching our shores. Troop recalls and a significant slimming of the public trough upon which defense contractors have been engorging themselves since even before Eisenhower's famous "military industrial complex" confession will be completed to ensure budget "neutrality", which is an arbitrary and utterly useless thing, since the only sustainable fiscal balance is the one that ensures full employment with product price stability. The time for a new national security directive has indeed arrived, and we urge all national governments to reconsider what the true basis of national security really is - a sustainable and thriving economy, and not one picked over by global speculative capital or its sock puppets politicians within the Predator State."
The more the bankers' interest is served, the worse and more debt-burdened the economy will become. Their gains have been bought at the price of domestic austerity. The G20 Communique irresponsibly and immorally ratifies this disgraceful state of affairs and we will all pay a severe price going forward.
The G20 policy makers, and their allies in finanzkapital, are like vultures picking over a dying carcass. And the rest of us are helpless because the institutions designed to serve broader public purpose have become subverted. We are making bond holders and big bankers whole at the expense of impoverishing the entire society.
It is hard to avoid drawing very dark conclusions. Our policy making elites have discovered that the underclass doesn't matter politically anymore, so why respond to it? That indifference is extending to the middle class. Ordinary, struggling folks are all becoming so demoralized that they present:
1. No voting threat, because none of the major political parties in Europe or the US genuinely represent their interests (and haven't for years). There have been, as a result, no political price to pay for such shameless predatory capitalism.
2. They present no power threat, because they have been systematically destroyed over the last 30 years and what is happening now in Europe represents the final assault on the residue of the 20th century welfare state (the US social safety net eviscerated well before this).
The message from the G20 seems to be this: We're through with domestic spending to employ the underclass.
There are decent jobs for about 20% of the working-age population in the west. And for the rest? Poverty a la South America. It is extraordinary that voters around the globe continue to tolerate this corrupt state of affairs, but it's getting increasingly hard to see a way out.
Roosevelt Institute Senior Fellow Marshall Auerback is a market analyst and commentator.
Rob Parenteau, CFA, is sole proprietor of MacroStrategy Edge, editor of The Richebacher Letter, and research associate at the Levy Economics Institute.