Tuesday, August 4, 2009

Red Ink, the Budget, and the Economic Outlook

Red Ink, the Budget, and the Economic Outlook
China Times editorial (Taipei, Taiwan, ROC)
A Translation
August 4, 2009

[ Editor's note: For the record, the Keynesian economic analysis and economic policy prescriptions recommended in this editorial are exactly wrong.

For the correct analysis and economic policy prescriptions, see:

The Myth of Good Government, by Llewellyn H. Rockwell, Jr.
http://www.lewrockwell.com/rockwell/myth-of-good-govt.html ]

The central government is working on next year's budget. Should the government concentrate on balancing the budget and reducing the deficit? Should it concentrate on limiting the expansion of fiscal policy and bolstering the economy? No one can agree. Now would be a good time to offer some views on the current situation, the prospects for the economy, and the lessons of history.

It has been nearly a year since the global financial tsunami broke out. Most economies are still experiencing negative growth. Their annual growth rates are negative. But their quarterly growth rates have turned positive. Taiwan's fourth quarter growth rate last year was -8.61%. This year's first quarter growth rate was -10.24%. This year's second quarter growth rate will be -8.5% In this year's fourth quarter however, the growth rate will be 5.2%. Last year's fourth quarter and this year's first quarter were both down over 5%. But this year's second quarter turned positive and showed a growth rate of 0.34% This year's third quarter showed a growth rate of 7.66%. Therefore the current tsunami probably bottomed out in the first quarter of this year.

Global financial markets have also rebounded strongly. The Dow now stands at 9000 points. The Hangseng has jumped to over 20,000 points. The Nikkei has zoomed to 10,000 points. The Shanghai Composite Index may return to 3400 points. The TAIEX has returned to 7000 points. Orders for listed companies and revenue expectations for the future have also turned positive. Although annual growth rates are still negative, quarterly or monthly growth rates are positive. Order visibility has been increased to several months. Based on these figures and on vendor reactions, we are undoubtedly seeing the seeds of recovery.

But as we revisit the past, so-called economic recovery is not a matter of course, straight-line trend. One must understand the cause of an economic downturn. Premature removal of the factors aiding economic recovery could cause the economy and financial markets to return to previous lows.

During the normal business cycle, economic decline naturally leads to lower interest rates and lower production costs. Eventually the economy reaches a point where manufacturers decide there is a profit to be made. Manufacturers increase their investments. Consumption gradually increases. And the economy gradually recovers. But in the event of a bubble economy and the financial turmoil that follows, national wealth is often substantially reduced. In order to survive, companies must drastically reduce corporate debt. Financial institutions are unable to provide loans. Companies across the nation deleverage themselves. At this point, one must rely on strong fiscal measures by the government to bridge the gaps. If the government prematurely withdraws its financial support, the economy may bottom out once again.

Japan's experience with a bubble economy is a living history lesson. After Japan's bubble economy of the 1990s burst, Japan lost more than half of her wealth. The economy depended entirely on 10 to 20 trillion yen in annual government debt. It was revived by fiscal policy support. This ensured that Japan's GDP would not be significantly reduced by the global recession. But in 1997, as the economy began to recover, the Ryutaro Hashimoto government promoted its fiscal consolidation program. As a result the economy immediately collapsed. It experienced five quarters of negative growth. In 2001 the Koizumi government made the same mistake. Koizumi trumpeted financial consolidation. He limited the amount of new bonds that could be issued annually to 30 trillion yen. This was insufficient to make up for the economic shortfall. The results was a rapid deterioration in the economy, and a blow to the financial markets.

What was the payoff for financial consolidation? The answer is, it was a negative one. Hashimoto's goal was to reduce the deficit by 15 trillion Yen. But the economy was dealt a serious blow. Major tax cuts were counterproductive, and eventually increased the deficit by 16 trillion Yen. Koizumi's fiscal consolidation ultimately increased the debt to 35 trillion Yen. Earlier, during the Great Depression of the 1930s, the United States government's New Deal fiscal stimulus led to an economic recovery. In 1937 however, in order to "balance the budget," it scaled back prematurely. It reduced expenditures. This dealt the economy another blow. Industrial production plummeted 33%. The stock market plummeted 50%. Instead of decreasing the deficit, it increased the deficit.

The financial tsunami has forced governments the world over to join hands to save the market. They have injected liquidity into financial markets. They have also adopted an expansionary fiscal policy. So far these policies have been effective. Global financial markets have rebounded. The real economy has successfully negotiated the trough, and is beginning to take off. Recently they held several large-scale international conferences. The participating countries agreed to consider exit mechanisms to avoid future inflation. But they also stressed that "now is not the time to exit."

Therefore, the government's 2010 budget will remain a deficit budget. Overall expenditures fell 3.8% from 2009. But an economic stimulus package will increase domestic demand. The budget adopted will reflect continued expansion. We believe that the weak economic recovery must continue to receive support. The government must make these expenditures and assume responsibility for them. During the coming year, domestic unemployment will continue to increase. The government must not prematurely withdraw its fiscal support in order to balance the budget.

But what about leaving the debt to our children and grandchildren? What are we to do about that? If the government attempts to balance the budget, and thereby reduce the debt left to our children and grandchildren, the results may be counterproductive. Japan's example is a warning. Once the economy has recovered and stabilized, tax revenue will naturally increase. The budget deficit can then be reduced. The government can gradually reduce the support it provides the economy. That will be the right time for fiscal consolidation.

中時電子報 新聞
中國時報  2009.08.04











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