July 9, 2012

Does Adding Government Debt Stimulate the Economy?

I was at a friend's house for a July 4th party when the host asked if I thought our economy was going to collapse. Immediately, I responded, "Of course it's possible, but I don't really think it will." That question was the catalyst for a 15-minute discussion on the state of the global economy. In this post, I'd like to elaborate, and perhaps, editorialize a bit. 

Our economy, as measured by GDP is about $15.4 trillion in size (as a historical reference point, this compares to $237 billion in the first quarter of 1947). However, when you compare U.S. GDP with the rest of the world, it's quite staggering. Our economy is over two and a half times larger than that of the next largest nation, China. It could be said that as the U.S. goes, so goes the world.

 

THE LARGEST GLOBAL ECONOMIES

Country/Area

GDP: $ T

Status

United States

15.4

In Recession?

Euro Area*

12.4

In Recession

China*

5.8

Slowing

Japan*

5.4

In Deflationary Trap

 *Source: TradingEcomonies 

I like to divide the world into three parts, the U.S., the Eurozone  and the emerging markets or rest of the world. For the past few years the emerging markets have been the bright spot, propping up global  growth. It has been my belief that if the U.S. and Europe could begin to grow at greater than 3.5% to 4.0% before the emerging markets slowed, then the global economy would be all right. However, as we now know, Europe is in recession, some believe we are as well (I don't believe we are, but I do think we're dangerously close) and ,of course, the emerging markets are slowing. 

Getting On Track

We have been in a massive experiment ever since the crisis first materialized; actually, I believe, since the mid 1930s. At the heart of this experiment is the Keynesian notion that government should engage in deficit spending if necessary to stimulate the economy. Economist and Nobel laureate Paul Krugman has written, in his blog and his New York Times column, that the reason this hasn't worked as well as expected is that we didn't spend enough. Now remind me, what's the criteria for awarding the Nobel Prize? Let's not forget that it's issued by Scandinavian committees. That's in Europe you know. You know...Europe....the place where the social experiment is collapsing.

Spend more? Really? Does Mr. Krugman actually believe we can grow our economy by adding more debt? More debt translates to higher taxes (to pay for the debt) which is a headwind to the private sector, which by the way, is where growth occurs! The experiment has failed miserably and it's time to move on. Admitting the problem is the first step. Perhaps, in fact, that is the problem.

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