Ideas Esteemed For Their Acceptability

A new wisdom has gone conventional. That's according to Paul Krugman anyway, whose column last Friday warned that the respected thinkers of the world are fast coming upon a new and sad conclusion: it's time to get austere. With the crisist-y part of the crisis now over, the argument goes, it's time for governments around the world to start cutting back before countries like Spain become countries like Greece and countries like Greece implode into homo-friendly Zimbabwes. It's an argument which has, according to Krugman, been recently "proliferating in op-eds, speeches and reports from international organizations." I haven't seen too many of these op-eds and I haven't heard too many of the speeches, but I sure have been hearing a lot about them from people like Paul Krugman. In the Financial Times and a half a dozen blogs and now for the third or fourth time in the New York Times, the conventional wisdom to which I've been exposed has not been that of the crisis of government debt, but of the crisis of the conventional wisdom of the crisis of government debt.

That being said, I was listening to an LSE public lecture podcast on my way home from work today in which Carlos Guitierrez, Secretary of Commerce under George W., stood in perfectly for Krugman's strawman Chicken Little. With the soft-spoken fatalism of the well-and self-assuredly informed, he regretfully informed the audience that government largess across the West would have to be trimmed--nay! slashed vigorously and unforgivingly (with spending cuts and tax increases, but mostly spending cuts). He talked a lot about Europe. And then with a wink and segue, he talked about the United States.

The first criticism to this new old way of thinking is predictable. Economies across the world are still largely fragile, if not totally in the shitter, and pulling the life-support now could cause another collapse. In any event, concerns over unsustainable debt or inflation seem particularly misplaced when looking at the U.S., where neither interest rates nor inflation seem anything other than historically low and stable. But I've blogged about that before, and recently too.

What might be a little more worrisome is the sudden ubiquity of the call to surplus. As Peter Dorman writes, with the OECD, the EU, the Obama Deficit Commission, and a growing number of U.S. Congressmen and women calling for the brakes, "[t]he deficit hawks seem to have forgotten, if they ever learned, the granddaddy of all accounting identities": with one person's debt being another person's asset (or to put it another way, with every borrower matched by a creditor), there is no way for everyone to pay down debt at the same time. It's functionally impossible.

In the grandest scheme of things, there are only a few ways for an economy to adjust to a government surplus. Looking at most of the countries in question, the adjustments that aren't very painful are very unlikely. Keeping in mind that total spending has to equal total income and that any change in the former must automatically translate into an equal change in the latter, the options are:

1) The government saves a bit more than it spends, the domestic private sector spend the difference, and the economy keeps chugging along.

But...
I doubt anyone would really anticipate this happening while private sector deleveraging and high unemployment are still a major facts of economic life in most Western democracies.

2) The government saves a bit more than it spends, foreign consumers spend the difference, and the economy keeps chugging along

But...
What's true in one country is likely to be true in the next one. And for problem economies like Greece, Spain, Portugal, and maybe Italy, more competitive exchange rates are off the table. At least, their off the table that doesn't involve the EMU crumbling around at the edges. But on a more fundamental note, from John Mauldin, "Every country cannot run a trade surplus. Someone has to buy...Yet politicians want to believe that somehow we all can run surpluses, at least in their country. We can balance the budgets. We can reduce our debts. We all want to believe in that mythical Lake Woebegone, where all the kids are above average."

3) The government saves a bit more than it spends, some combination of the domestic private sector and foreign consumers spend the difference, and the economy keeps chugging along.

Check out my previous Buts.

4) The governments saves a bit more and no one spends the difference (at least, not enough to compensate the decrease in total spending); with less total spending, total incomes across the economy decline by difference; tax revenue falls accordingly.

Or, to put it another way, private sector indebtedness increases by exactly as much as the government surplus. This is not because fiscal thrift magically induces the public to get irresponsible, but because in the absence of any other spending, by accounting necessity, the income withdrawn from the economy by the government will show up as a decline in income on the private side. With total private debt left unchanged, household indebtedness increases.

Back to John Mauldin, "You can run a trade deficit, reduce government debt and reduce private debt but not all three at the same time." In Greece, with constraints on its ability to borrow or adjust via the exchange rate, this is a real dilemma, not so for the U.S.