Friday, June 25, 2010

The Limits of Stimulus

What is the point of Keynesianism and economic "stimulus?" Is it all just political gamesmanship--naive inflationism and politically-connected economists truckling to politicians who always need another justifiction to spend?

The Reason chaps are having their fun with the New York Times' Paul Krugman. Who is still calling for more "stimulus." Trillions, not billions. Even more stimulus after the trillions already thrown over the side. But the Europeans don't like it. As Tim Cavanaugh writes:

Europeans have lost their appetite for digging deeper holes of debt for the same reason Americans have: because they don't have a choice. As Margaret Thatcher predicted would happen, we have all run out of other people's money.

That is to say: Europeans are worried about sovereign default, meaning that the government can't borrow any more to fund stimulus. Why? Because just like a homeowner with an adjustable-rate mortgage, there comes a time when the interest payment becomes so high that you can't pay for policemen and firemen and teachers and health care and government pensions.

The financial markets are worried that Greekonomics, the inability to service government debt, is likely to spread.

I've decided that the point of stimulus is quite simple, despite all the clouds of rhetoric. It is to float the underwater debtors. Capitalism is simple. If the debtors are afloat, meaning that their assets exceed their liabilities, and the market is confident that they are afloat, then the world goes on. Creditors can trust that debtors will meet their interest payments.

But if debtors are underwater, then nobody knows when the debtors will default. That goes for governments, bankers, corporations, and homeowners. In that situation creditors are right to lose confidence in the underwater debtors.

Keynesianism is the economic doctrine that the government should print and borrow money in an economic crisis. The purpose is to float the debtors. And the government should spend money to push money towards the underwater debtors and thus enable them to meet their obligations and, hopefully, increase asset prices and thus refloat the underwater debtors.

The question is this. Once you have refloated the banks, as the US government did in the fall of 2008, is there a need for stimulus?

Well, I'd say that, once the banks are rescued, then it is time for triage, as practiced by J.P. Morgan in 1907.

Morgan and the richest men in the US sat in a room and decided which companies to lend money to. Hopeless case? No money. Likely to survive without a loan? No money. The only debtors Morgan lent money to were companies he thought he could save with a loan.

Notice the difference between then and now. The banks have been rescued. Thanks Hank Paulson. But you have to rescue the banks, otherwise "this sucker could go down," in the words of President Bush.

But auto companies? Who needs to rescue auto companies? Yeah. The criterion of Obama bailouts is politics. And the criterion of Obama stimulus is politics. The politically powerful get rescued and the rest go to the wall.

Not a good way to run a railroad.

OK. But what about lessons learned? The lesson is that we need a lot less leverage in the economy. The excessive leverage and debt is not the fault of greedy bankers. It is the fault of politicians. Politicians like easy money and excessive debt because voters and organized interests are always agitating for cheap money.

But excessive debt means that debtors can't afford a decline in asset prices, e.g., houses. When you shovel credit at the housing market with Fannie and Freddie, you push up housing prices with your 90 percent and zero-down loans. All it takes is a decline in home prices of ten percent and a ton of people are underwater.

What about overleveraged banks. There was an excuse for bank leverage in the old days. In the old days there wasn't an organized market in equities. Banking was the only efficient way to channel capital through the economy.

But today we have a market in just about everything. So a lot of today's leverage could be transformed into equity.

And equity is so much more civilized.

Debt is rigid. I lend you money and you pay me a fixed interest. Or else. Equity is flexible. I invest money in your enterprise and now we are partners. We share in the profits and we share in the losses.

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