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The Ominous Message in 2 Centuries of Global Public Finances | CYNICONOMICS

The Ominous Message in 2 Centuries of Global Public Finances | CYNICONOMICS.

Posted on February 26, 2014 by ffwiley

After our recent article showing the history of non-defense budget balances for large, developed countries, some readers wondered how our results might change with defense spending included.

Here’s a new chart showing total budget balances:

 

fiscal balance with defense

As in the first chart, we started in 1816 with four countries (the U.S., U.K., France and Netherlands) and then added seven more at different points in time, while weighting each country by its GDP. (Click here for data sources and more details.)

New chart, same story

The message is basically the same, regardless of whether you isolate non-defense budget balances as in the earlier chart or look at total balances as above.

That is, current fiscal risks are unlike any the world has ever seen.

Echoing our thoughts from the earlier post:

The [growing deficits of the past 50 years] suggest that we’ve never been in a predicament comparable to today. Essentially, the world’s developed countries are following the same path that’s failed, time and again, in chronically insolvent nations of the developing world.

Look at it this way: the chart shows that we’ve turned the economic development process inside out. Ideally, advanced economies would stick to the disciplined financial practices that helped make them strong between the early-19th and mid-20th centuries, while emerging economies would “catch up” by building similar track records. Instead, advanced economies are catching down and threatening to throw the entire world into the kind of recurring crisis mode to which you’re accustomed if you live in, say, Buenos Aires.

The diminishing ability of wars to explain public finances

The new chart shows more clearly how the purposes of public borrowing have evolved. In the 19th and early-20th centuries, governments borrowed mostly to fund wars. In fact, any military history is incomplete without consideration of warring nations’ access to capital. You can argue that government borrowing not only enables wars, but that the ability to borrow heavily is a major determinant of whether your army wins or loses, more important in many cases than military prowess.

(Niall Ferguson claims exactly this in his bestseller, The Ascent of Money: A Financial History of the World

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. Are you interested in the Napoleonic Wars, U.S. Civil War and World War 1 – three periods of significant public borrowing as shown in the chart? Ferguson links the ultimate outcomes of each of these wars to the victors’ superior access to government bond investors.) 

Fast forward to today, and deficits have broken free of the costs of tanks, bombs and warplanes. Considering current public finances, it’s hard to imagine another widespread war that doesn’t lead to financial mayhem. A surge in military spending would surely end any hopes that large, developed nations won’t eventually be forced into defaults and/or wealth confiscation.

Worse still, it’s looking more and more as though we’re headed for disaster even without a future spike in military spending. The risks of a severe fiscal crisis are obvious in our earlier chart showing non-defense budget balances, and they’re just as apparent with defense spending added back in.

Bonus chart

The chart below separates budget balances into two pieces – the non-defense portion (as in the earlier post) and defense spending. We’ll add more detail in the future, including a country-by-country breakdown of the underlying data.

fiscal balance ex-defense 2

The Ominous Message in 2 Centuries of Global Public Finances | CYNICONOMICS

The Ominous Message in 2 Centuries of Global Public Finances | CYNICONOMICS.

Posted on February 26, 2014 by ffwiley

After our recent article showing the history of non-defense budget balances for large, developed countries, some readers wondered how our results might change with defense spending included.

Here’s a new chart showing total budget balances:

 

fiscal balance with defense

As in the first chart, we started in 1816 with four countries (the U.S., U.K., France and Netherlands) and then added seven more at different points in time, while weighting each country by its GDP. (Click here for data sources and more details.)

New chart, same story

The message is basically the same, regardless of whether you isolate non-defense budget balances as in the earlier chart or look at total balances as above.

That is, current fiscal risks are unlike any the world has ever seen.

Echoing our thoughts from the earlier post:

The [growing deficits of the past 50 years] suggest that we’ve never been in a predicament comparable to today. Essentially, the world’s developed countries are following the same path that’s failed, time and again, in chronically insolvent nations of the developing world.

Look at it this way: the chart shows that we’ve turned the economic development process inside out. Ideally, advanced economies would stick to the disciplined financial practices that helped make them strong between the early-19th and mid-20th centuries, while emerging economies would “catch up” by building similar track records. Instead, advanced economies are catching down and threatening to throw the entire world into the kind of recurring crisis mode to which you’re accustomed if you live in, say, Buenos Aires.

The diminishing ability of wars to explain public finances

The new chart shows more clearly how the purposes of public borrowing have evolved. In the 19th and early-20th centuries, governments borrowed mostly to fund wars. In fact, any military history is incomplete without consideration of warring nations’ access to capital. You can argue that government borrowing not only enables wars, but that the ability to borrow heavily is a major determinant of whether your army wins or loses, more important in many cases than military prowess.

(Niall Ferguson claims exactly this in his bestseller, The Ascent of Money: A Financial History of the World

img

img

. Are you interested in the Napoleonic Wars, U.S. Civil War and World War 1 – three periods of significant public borrowing as shown in the chart? Ferguson links the ultimate outcomes of each of these wars to the victors’ superior access to government bond investors.) 

Fast forward to today, and deficits have broken free of the costs of tanks, bombs and warplanes. Considering current public finances, it’s hard to imagine another widespread war that doesn’t lead to financial mayhem. A surge in military spending would surely end any hopes that large, developed nations won’t eventually be forced into defaults and/or wealth confiscation.

Worse still, it’s looking more and more as though we’re headed for disaster even without a future spike in military spending. The risks of a severe fiscal crisis are obvious in our earlier chart showing non-defense budget balances, and they’re just as apparent with defense spending added back in.

Bonus chart

The chart below separates budget balances into two pieces – the non-defense portion (as in the earlier post) and defense spending. We’ll add more detail in the future, including a country-by-country breakdown of the underlying data.

fiscal balance ex-defense 2

Bad News for Keynesians: Data Shows the Austerians Are Right | CYNICONOMICS

 

Anders Aslund of the Peterson Institute recently made an interesting argument about Europe’s winners and losers. In a critique of Paul Krugman’s advice to Europe’s political leaders, he compares economic performance of the southern European laggards to the northern countries and, in particular, the Baltic states.

Aslund concludes that:

Today, the record is clear. The countries that have followed [Krugman’s] advice and increased their deficits (the South European crisis countries), have done far worse in terms of economic growth and employment than the North Europeans and particularly the Baltic countries that honored fiscal responsibility.

He also links fiscal adjustments to structural reforms:

Thanks to greater structural adjustment, the growth trajectory is likely to be higher in countries that quickly and enthusiastically embrace these reforms than elsewhere. Accordingly, the three Baltic countries that suffered the largest output falls at the outset of the crisis because of a severe liquidity freeze returned to growth within two years and have, over the same period, enjoyed the highest growth in the EU. By contrast, Greece, with its back-loaded fiscal adjustment, as recommended by Krugman, has suffered from six years of recession.

By comparing past reforms to recent growth, Aslund takes a sensible approach. But he focuses mostly on the tiny Baltics and secondly on continental Europe, which begs the question:  What about larger countries everywhere?

Let’s have a look.

We start with every country that has both a global GDP share of greater than 0.25% in 2007 (pre-global financial crisis) and sufficient data on fiscal balances and growth. This is 47 countries. We then divide the group into a European sub-group (23 countries) and a non-European sub-group (24 countries). For each sub-group, we compare real GDP growth for 2010 to 2012 (post-GFC) to the average structural budget balance for 2008 and 2009 (during the GFC).

Here are the results:

growth and budgets chart 1

growth and budgets chart 2

Not only is there a positive relationship between stronger public finances during the crisis and faster post-GFC growth, but the relationship holds both within and outside Europe. (For those who like statistics, the F-stat for the European regression is significant at 99.9%, while the other regression is significant at 90% but not 95%.)

Conclusions

We have two observations. First, the results may help explain why Keynesian pundits resort to nonsensical arguments. They often claim that poor performance in countries attempting to contain public debt proves austerity doesn’t work, which is like deciding your months in rehab stunk, and therefore, rehab is bad and heroin is good. A more honest approach is to compare fiscal actions in one time period with results in later periods, after the obvious short-term effects have played out. But if Keynesians did that, they would reveal that their own advice has failed.

Second, the effects discussed by Aslund don’t receive enough attention. As Tyler Cowen (who gets credit for the pointer) wrote, Aslund’s perspective “is underrepresented in the economics blogosphere.”

And that includes our wee blog.

Regular readers know that we’ve presented research on long-term fiscal policy effects. (For example, see our historical study of 63 high government debt episodes, or our Fonzie-Ponzi theory.) We’ve also argued that the short-term consequences of fiscal tightening, often said to support Keynesian policies as noted above, actually do just the opposite. (Consider that fiscal tightening is motivated by today’s massive debt burdens, and these happen to be explained best by Keynesianism – the deficit spending policies of the past that hooked economies on unsustainable finances in the first place.)

But until now, we haven’t offered research on intermediate-term effects – horizons of 2-5 years as in the charts above. And this evidence supports Aslund’s conclusions.Policymakers should heed his argument that “front-loaded fiscal adjustment quickly restores confidence, brings down interest rates, and leads to an early return to growth.”

(Click here for the country-by-country data that was used in the charts.)

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Bad News for Keynesians: Data Shows the Austerians Are Right | CYNICONOMICS.

 

 

Scotiabank Warns “Yellen Has Ensured An Equity Market Crash Is Inevitable” | Zero Hedge

Scotiabank Warns “Yellen Has Ensured An Equity Market Crash Is Inevitable” | Zero Hedge.

Authored by Guy Haselmann of Scotiabank,

FED – Encouraging the Melt-Up Trade, While Regulating Bubbles Away   

The Fed moved ‘all-in’ in 2008/09 when it pushed rates to zero and embarked on QE. Since the Fed basically used its final chips via this action, it became trapped playing ‘this hand’ until the bitter end. The stakes are enormous and grow over time. The only way the Fed can ‘win’ is – as Yellen said today – “to do everything possible to promote a very strong recovery”. Tapering too soon could be calamitous toward this objective. Yet, the longer it continues, the more the risks aggregate.  However, Yellen seemed to calmly indicate today that any unintended consequences or dangers to financial stability are worth the risk.

There is an inability, and lack of good options, for providing any additional monetary or fiscal accommodation, should the economy weaken or should a global crisis arise. This is what makes the Fed’s current policy experiment such a high-stakes experiment. Here is why policy-makers are in such a predicament:

Every economic or business cycle decline over the past three decades has been met with the same response: monetary or fiscal stimulus.  Policy makers have been quick to offer accommodation, but they have been slow to withdraw the stimulus which is always politically more difficult.

 

Fiscal accommodation over the years has resulted in large deficits and debt which are now leading to contentious discussion about how to reel them in.

 

Monetary authorities have stair-stepped the Fed Funds Rate down, but eventually hit zero and ran out of room.

 

Effectively, both stimulatory mechanisms are broken.

Yellen had to field several questions about potential market bubbles, but she deflected them aggressively saying that she did not believe that “bubble-like conditions” existed.  Whether she believes that or not, it would have been counter-productive for her to admit it.  She mentioned that should bubbles begin to form, the Fed has the regulatory tools to control them.  She can’t possibly believe this (or can she); but regardless, she must try to convince the market that the Fed is monitoring them and can contain them.

Basically, she has given the market the green light to “melt-up”.  The only question is how much higher will the Fed’s ‘gift’ drive prices? She indicated the Fed has no choice but to continue with this policy until it succeeds (or will it ultimately fail?).

 

As perverse as this seems, Yellen likely ensured that an equity market crash (someday) is inevitable.  Yellen’s failure to acknowledge any signs of bubble-like conditions encourages more risk-taking and speculation.  Therefore, this fact, combined with her hints of a continuation of policy, should lead to a bubble; if one hasn’t been created already.  And, all bubbles eventually pop.

 

Alternatively, it is possible that Fed policy fails and economic growth begins to slip. In this scenario, a significant re-pricing (lower) of financial assets would occur.

 

Since banks are in a much stronger position today than in 2008, the Fed probably has limited concern about a market crash – as long as the banking system remains healthy.  The Fed probably doubts a crash could be as bad as 2008, and it know it know possesses a slew of liquidity facilities (established in 2008) which could be implemented quickly if necessary.

“The question isn’t who is going to let me; it’s who is going to stop me.” – Ayn Rand

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