Free Markets, Free People

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Can you solve the debt crisis by creating more debt?

Most intuitively know you can’t borrow your way out of debt, so it seems like a silly question on its face.  But the theory is that government spending creates a simulative effect that gets the economy going and pays back the deficit spending in increased tax revenues.  $14 trillion of debt argues strongly that the second part of that equation has never worked.

The current administration and any number of economists still believe that’s the answer to the debt crisis now and argue that deficit spending will indeed get us out of the economic doldrums we’re in.  William Gross at PIMCO tells you why that’s not going to work:

Structural growth problems in developed economies cannot be solved by a magic penny or a magic trillion dollar bill, for that matter. If (1) globalization is precluding the hiring of domestic labor due to cheaper alternatives in developing countries, then rock-bottom yields can do little to change the minds of corporate decision makers. If (2) technological innovation is destroying retail book and record stores, as well as theaters and retail shopping centers nationwide due to online retailers, then what do low cap rates matter to Macy’s or Walmart in terms of future store expansion? If (3) U.S. and Euroland boomers are beginning to retire or at least plan more seriously for retirement, why will lower interest rates cause them to spend more? As a matter of fact, savers will have to save more just to replicate their expected retirement income from bank CDs or Treasuries that used to yield 5% and now offer something close to nothing.

My original question – “Can you solve a debt crisis by creating more debt?” – must continue to be answered in the negative, because that debt – low yielding as it is – is not creating growth. Instead, we are seeing: minimal job creation, historically low investment, consumption turning into savings and GDP growth at less than New Normal levels.

Not good news, but certainly the reality of the situation.  Deficit spending has been the panacea that has been attempted by government whenever there has been an economic downturn.  Some will argue it has been effective in the past and some will argue otherwise.   But if you read through the 3 points Gross makes, even if you are a believer in deficit spending in times of economic downturn, you have to realize that there are other reasons – important reasons – that argue such intervention will be both expensive and basically useless.

We are in the middle of a global economy resetting itself.  Technology is one of the major drivers and its expansion is tearing apart traditional institutions in the favor of new ones that unfortunately don’t depend as heavily on workers.

Much of the public assumes we’ll return to the Old Normal.  But one has to wonder, as Gross points out, whether we’re not going to stay at the New Normal for quite some time as economies adjust.   And while it will be a short term negative, the Boomer retirements will actually end up being a good thing in the upcoming decades as there will be fewer workers competing for fewer jobs.

But what should be clear to all, without serious adjustments and changes, the welfare state, as we know it today, is over.  Economies can’t support it anymore.   That’s what you see going on in Europe today – its death throes.   And it isn’t a pretty picture.

So?  So increased government spending isn’t the answer.  And the answer to Gross’s question, as he says, is “no”. 

The next question is how do we get that across to the administration (and party) which seems to remain convinced that spending like a drunken sailor on shore leave in Hong Kong is the key to turning the economy around and to electoral salvation?


Twitter: @McQandO