Don't Bet on a Recovery

It is astounding how many economists, government officials, and Wall Street strategists construe the current economic conditions as evidence of a bona fide recovery. It is a testament to the power of the rose-colored glasses handed out by our nation's leading universities that such a feeling could be widely held despite the clear and present danger that compounds daily. The myopia leads us to enact policies that actually exacerbate our problems. The "remedies" are postponing, perhaps indefinitely, a true recovery.

The oracles who have described the nature of this imminent recovery do so based on their conviction that consumer spending is slowly returning to levels that existed prior to the recession. New data released today seems to support this view, with consumer spending up 0.5% in January.

However, missing from their analysis is any plausible explanation as to why consumers will be able to sustain such spending given the plunge in income and credit, and the lack of available savings. In fact, the same January spending report showed that personal income increased by only 0.1%, while the savings rate slowed to the smallest since 2008.

I would challenge those who fantasize about a consumer-led recovery to describe where the spending money will come from. Most consumers are tapped out, millions are unemployed, and home equity has been wiped out. The only reasonable thing for them to do is to pay down debt and sock away as much money as possible to rebuild their savings.

Beyond the question of "how" the spending could be achieved, is the deeper question of "why" such activity should be sought at all. Excessive spending, fuelled by an insane housing bubble and catalysed by reckless monetary and fiscal policy, was the reason that our current recession became unavoidable. Why would we want to go down that road again?

During the run up to the crash, excess spending had created economic distortions that have yet to be resolved. Too many resources, including land, labour, and capital, were devoted to servicing an unsustainable economic model in which Americans borrowed money to buy homes, products and services they really could not afford. In many cases consumer behaviour was influenced by overly optimistic assumptions regarding real estate related riches.

However, now that the real estate bubble has burst, Americans are coming to terms with a more sober reality. Many have cut up their credit cards, dramatically reduced their spending, and have squirreled away as much money as they can. This change in behaviour should necessitate a dramatic shift in the labour market as workers move away from jobs associated with consumer spending and toward jobs associated with real production, primarily for exportable goods.

The real problem is that monetary and fiscal policy designed to re-inflate the burst spending bubble is preventing this transition from taking place. As a result we are not creating the jobs we need to replace - the ones we have lost in mortgage servicing, home improvement, and real estate sales (which we never really needed to begin with). As these jobless remain unable to find alternative employment, our economy will continue to languish.

Some will argue that the new jobs created by government stimulus spending will provide the additional purchasing power necessary to revitalize consumer spending. There are two problems with this expectation. First, those jobs being "created" by the government are outnumbered by those being destroyed by government domination of resources. Second, even if it were possible for job growth to return, having hopefully learned from their mistakes, workers will be far more frugal with their pay checks than they were in the past.

Others hope that rising real estate prices will give consumers more confidence to spend. The reality is that housing prices are still too high and will likely fall further. But even if they did rise, consumers will still be reluctant to resume their shopping spree. Home equity extraction loans, which just a few years ago turned houses into ATMs, are now much harder to come by. When it comes to spending, it's not just about confidence; it's about cash.

The only possible way consumers can spend is if the government gives them the money. However, since the government cannot legitimately give money to one American without first taking it from another, the most likely means of doling out cash will be to run it off the printing presses.

That, in a nutshell, is our government's plan for economic recovery. Print a bunch of money and give it to consumers to spend. This is not a plan for recovery but a recipe for disaster. Those betting that this program can succeed in putting together a healthy and sustainable economy simply do not understand the nature of their wager. The smart money is going the other way.

Regards,

Peter Schiff
for The Daily Reckoning Australia 

Intervention and Economic Crisis

by Thomas E. Woods, Jr.by Thomas E. Woods, Jr.
Recently by Thomas E. Woods, Jr.: 

Catholic Social Teaching and the Market Economy Revisited: A Reply to Thomas Storck

No supporter of the market economy could have been surprised when the recent financial crisis was inevitably blamed on “capitalism” and “deregulation.” The free market, we were told, was a recipe for financial instability. “Advocates of the free market must confront the fact that both the Great Depression and the current financial chaos were preceded by years of laissez-faire economic policies,” wrote Katrina van den Heuvel, editor of The Nation, and author Eric Schlossel, in September 2008.

It is not enough to call this a distortion of the truth. It is a grotesque distortion, worthy of the Soviet politburo. The crisis is in fact the altogether predictable fruit of massive government and central-bank distortions of the economy. That may be why the free-market economists of the Austrian School were practically the only ones to have seen it coming.

But although there is no question that those factors exacerbated the problems that led to the crisis, they are not the primary culprits. Britain has also experienced a housing collapse, even though there is no British analogue of Fannie, Freddie, and the CRA. Moreover, no matter what encouragements these and other institutions may have given to home purchases, where did all the money come from to buy all those houses and drive up their prices so high so quickly?There has been much discussion on right-wing radio and in the conservative press about Fannie Mae, Freddie Mac, and the Community Reinvestment Act (CRA), which have been described as forms of government intervention that contributed to the financial crisis. To a certain extent that is all well and good: Fannie and Freddie enjoyed special government-granted privileges, along with an implicit bailout guarantee, that allowed them to become much more substantial actors in the secondary mortgage market than would have been possible in a free market. Furthermore, politicizing the lending process and cajoling banks into abandoning traditional standards of creditworthiness cannot make a positive contribution to the health of the banking industry.


We should instead focus on the Federal Reserve System, an institution few Americans know much about but which, in addition to systematically undermining the value of the U.S. dollar – which has lost at least 95 percent of its value under the Fed’s supervision – gives rise to the boom-bust business cycle.

Economist F.A. Hayek wanted to understand why the economy moved in a boom-bust pattern – why there was, in the words of the British economist Lionel Robbins, a sudden “cluster of error” among entrepreneurs. Why should the people the market has rewarded in the past for their skill at anticipating consumer demand suddenly commit serious errors and all in the same direction?


A business-cycle primer


Hayek won the Nobel Prize for his answer.
Building on the insights of Ludwig von Mises, who first began to develop what is known as Austrian business-cycle theory in his book The Theory of Money and Credit in 1912, Hayek pinpointed the central bank’s artificial creation of credit as the nonmarket culprit in the business cycle. (Economist Jesús Huerta de Soto applies Austrian business-cycle theory to cycles that occur in countries that have lacked a central bank in his treatise Money, Bank Credit, and Economic Cycles.)

Scenario 1. Consider what happens when the public increases its savings. Since banks now have more funds to lend (namely, the saved funds deposited by the public), the rate of interest it charges on loans will fall. The lower interest rates, in turn, stimulate an expansion in long-term investment projects, which are more sensitive to interest rates than short-term projects are. (Think of the difference in the decline in monthly payments that would occur between a 30-year mortgage and a 1-year mortgage if interest rates came down by even 2 percentage points.)To understand Hayek’s point, which exonerates the free market, consider two scenarios.
Lower-order stages of production are those stages closest to finished consumer goods: retail stores, services, and the like. Wholesale and marketing are examples of higher-order stages. Mining, construction, and research and development are of still higher order, since they are so remote from the finished good that reaches the consumer. When people’s consumption spending contracts, it is a perfect time for higher-order stages of production to expand: because of people’s additional saving, there is relatively less demand for consumer goods, and the resulting contraction of lower-order stages of production will release resources for use in the higher-order stages.


Scenario 2. Government-established central banks have various means at their disposal to force interest rates lower even without any corresponding increase in saving by the public. (For more on this, see The Mystery of Banking, by Murray N. Rothbard, or his shorter classic, What Has Government Done to Our Money?) Just as in the case in which public saving has increased, the lower interest rates spur expansion in higher-order stages of production.

The difference, though, is a critical one and guarantees that these artificially low interest rates will not yield the happy outcome we saw in Scenario 1. For in this case, people have not decreased their consumption spending. If anything, the low interest rates encourage further consumption. If consumption spending is not constricted, the lower-order stages of production do not contract. And if they do not contract, they do not release resources for use in the higher-order stages of production. Instead of harmonious economic development, there will instead ensue a tug of war for those resources between the higher and lower stages. In the process of this tug of war, the prices of those resources (labor, trucking services, et cetera) will be bid up, thereby threatening the profitability of higher-order projects that were begun without the expectation of this increase in costs.


Preventing correction
As the workers in the newly expanded higher-order stages of production begin to spend their incomes, they spend according to the same saving-to-consumption ratio they did in the past. Their desire to save, and thereby to sustain all this long-term investment, turns out to be not as great as the distorted structure of interest rates led entrepreneurs to believe. It becomes ever clearer that society is not prepared to support the expansion of time-consuming higher-order stages of production. They do not wish to save enough resources to make the completion of all the new projects possible. The lower-order stages will win the tug of war. Expansion in the higher-order stages will have to be abandoned. Some of the resources deployed there will be salvageable; others will have been squandered forever or will be of little to no use in later stages of production.


The economywide discoordination that reveals itself in the bust is not, therefore, caused by the free market. To the contrary, it isintervention into the free market, in the form of distortions of the structure of interest rates – which are crucial coordinating mechanisms – that causes the problem.
As the boom turns into bust, the economy tries to readjust itself into a configuration that conforms to consumer preferences. That is why it is so essential for government to stay entirely out of the adjustment process, because arbitrary government behavior can only delay this necessary and healthy process. Wages and prices need to be free to fluctuate, so labor and other resources can be swiftly shifted away from bloated, bubble sectors of the economy and into sustainable sectors of the economy where consumers want them. Bailouts obstruct that process by preventing the reallocation of capital into the hands of firms that genuinely cater to consumer demand, and by propping up instead those firms that have deployed resources in ways that do not conform to consumer preferences. Fiscal and monetary stimulus do nothing to address the imbalances in the economy, and indeed only perpetuate them.

Most observers cheered in the months following 9/11 when it seemed as if Alan Greenspan had successfully navigated the economy through the dot-com bust at the cost of only a relatively mild recession. The man the New York Times identified as “the infallible maestro of our financial system” had lived up to the expectations of those who treated him with a distinctly creepy reverence. But all he had done was hold off the inevitable recession, and make the current downturn all the worse. The recession of 2001 was the only one on record in which housing starts did not decline. Thus people drew the false conclusion – amplified by the alleged experts, including Fed economists – that the housing sector is robust through thick and thin, housing prices never fall, a house is the best investment someone can make, and so on.


Moral hazard
Because Greenspan would not allow the full correction to take place, clearing out entrepreneurial errors caused by his previous intervention, market actors persisted in their errors for years thereafter. With the economy having continued along its unsustainable trajectory all that time, the bust that inevitably came was that much worse. Although market decisions were distorted in countless areas of industry, it was housing whose disproportionate growth was most obvious in the most recent boom. Easy money by the Fed, combined with government regulations that made mortgage loans especially easy and attractive, gave rise to a housing bubble – in other words, an array of prices that were unsustainably high. Housing is a durable consumer good generally purchased with long-term financing, so it fits in perfectly with the Austrian analysis that artificially low interest rates give undue stimulus to long-term projects.


There has been much discussion of moral hazard in connection with the flurry of bailouts that began in 2008. “Moral hazard” refers to people’s readiness to act with an artificially elevated level of risk tolerance because they believe that any losses they may incur will be borne by other people. Hence the bailouts will tend to make major market actors even less likely to behave prudently in the future, since if they believe they are likely to be considered “too big to fail,” they have more reason than ever to believe that they will not be allowed to go out of business, and therefore that they may continue to make risky bets.


This critique is correct as far as it goes, but it overlooks the related problem that the very existence of a central bank such as the Federal Reserve aggravates – indeed, institutionalizes – moral hazard. Since there is no physical limitation on the creation of paper money, firms know that no natural constraint exists on the power of the central bank to bail them out of any serious trouble. (Even if the supply of paper should be exhausted, the monetary authority can always add zeroes to existing notes.) In our own case, financial commentators spoke of the “Greenspan put,” the implied promise that the central bank would intervene to assist the financial sector in the event of a serious downturn. No one has a right to be surprised when market actors behave accordingly. 


The Ethics of Money Production


The banks must keep certain minimum amounts of equity and reserves, they must observe a great number of rules in granting credit, their executives must have certain qualifications, and so on. Yet these stipulations trim the branches without attacking the root. They seek to curb certain known excesses that spring from moral hazard, but they do not eradicate moral hazard itself. As we have seen, moral hazard is implied in the very existence of paper money. Because a paper-money producer can bail out virtually anybody, the citizens become reckless in their speculations; they count on him to bail them out, especially when many other people do the same thing. To fight such behavior effectively, one must abolish paper money. Regulations merely drive the reckless behavior into new channels.

One might advocate the pragmatic stance of fighting moral hazard on an ad hoc basis wherever it shows up. Thus one would regulate one industry after another, until the entire economy is caught up in a web of micro-regulations. This would of course provide some sort of order, but it would be the order of a cemetery. Nobody could make any (potentially reckless!) investment decisions anymore. Everything would have to follow rules set up by the legislature. In short, the only way to fight moral hazard without destroying its source, fiat inflation, is to subject the economy to a Soviet-style central plan.

Since 2007 the typical pattern has unfolded before our eyes: a financial crisis whose ultimate cause is the government’s own central bank is blamed on anyone and everyone else, while the central bank itself is portrayed as our savior rather than the culprit. This version of events is then used to justify still more expansions of government power.
It is urgently necessary for Americans to inoculate themselves against the relentless propaganda in behalf of the government’s version of the story. That’s why I wrote my book Meltdown earlier this year: to set forth a persuasive free-market explanation of the crisis that laymen can understand and use. It spent ten weeks as a New York Times best-seller, but the Times has refused to review it. That, in turn, is about the best endorsement I could have asked for.

February 26, 2010

Thomas E. Woods, Jr. [visit his website; send him mail] is the author of nine books, including two New York Times bestsellers: Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse and The Politically Incorrect Guide to American History. Read Congressman Ron Paul's foreword to Meltdown.

Copyright © 2010 Future of Freedom Foundation

Munger: Basically, it's over

This is very good, and from perhaps the equal first most successful investor ever (= with Buffett).

Basically, It's Over 

A parable about how one nation came to financial ruin. 

By Charles Munger 

Updated  Sunday, Feb. 21, 2010, at 3:30 PM ET 

In the early 1700s, Europeans discovered in the Pacific Ocean a large, unpopulated island with a temperate climate, rich in all nature's bounty except coal, oil, and natural gas. Reflecting its lack of civilization, they named this island "Basicland."  

The Europeans rapidly repopulated Basicland, creating a new nation. They installed a system of government like that of the early United States. There was much encouragement of trade, and no internal tariff or other impediment to such trade. Property rights were greatly respected and strongly enforced. The banking system was simple. It adapted to a national ethos that sought to provide a sound currency, efficient trade, and ample loans for credit-worthy businesses while strongly discouraging loans to the incompetent or for ordinary daily purchases. 

Moreover, almost no debt was used to purchase or carry securities or other investments, including real estate and tangible personal property. The one exception was the widespread presence of secured, high-down-payment, fully amortizing, fixed-rate loans on sound houses, other real estate, vehicles, and appliances, to be used by industrious persons who lived within their means. Speculation in Basicland's security and commodity markets was always rigorously discouraged and remained small. There was no trading in options on securities or in derivatives other than "plain vanilla" commodity contracts cleared through responsible exchanges under laws that greatly limited use of financial leverage. 

In its first 150 years, the government of Basicland spent no more than 7 percent of its gross domestic product in providing its citizens with essential services such as fire protection, water, sewage and garbage removal, some education, defense forces, courts, and immigration control. A strong family-oriented culture emphasizing duty to relatives, plus considerable private charity, provided the only social safety net. 

The tax system was also simple. In the early years, governmental revenues came almost entirely from import duties, and taxes received matched government expenditures. There was never much debt outstanding in the form of government bonds. 

As Adam Smith would have expected, GDP per person grew steadily. Indeed, in the modern area it grew in real terms at 3 percent per year, decade after decade, until Basicland led the world in GDP per person. As this happened, taxes on sales, income, property, and payrolls were introduced. Eventually total taxes, matched by total government expenditures, amounted to 35 percent of GDP. The revenue from increased taxes was spent on more government-run education and a substantial government-run social safety net, including medical care and pensions. 

A regular increase in such tax-financed government spending, under systems hard to "game" by the unworthy, was considered a moral imperative—a sort of egality-promoting national dividend—so long as growth of such spending was kept well below the growth rate of the country's GDP per person. 

Basicland also sought to avoid trouble through a policy that kept imports and exports in near balance, with each amounting to about 25 percent of GDP. Some citizens were initially nervous because 60 percent of imports consisted of absolutely essential coal and oil. But, as the years rolled by with no terrible consequences from this dependency, such worry melted away. 

Basicland was exceptionally creditworthy, with no significant deficit ever allowed. And the present value of large "off-book" promises to provide future medical care and pensions appeared unlikely to cause problems, given Basicland's steady 3 percent growth in GDP per person and restraint in making unfunded promises. Basicland seemed to have a system that would long assure its felicity and long induce other nations to follow its example—thus improving the welfare of all humanity. 

But even a country as cautious, sound, and generous as Basicland could come to ruin if it failed to address the dangers that can be caused by the ordinary accidents of life. These dangers were significant by 2012, when the extreme prosperity of Basicland had created a peculiar outcome: As their affluence and leisure time grew, Basicland's citizens more and more whiled away their time in the excitement of casino gambling. Most casino revenue now came from bets on security prices under a system used in the 1920s in the United States and called "the bucket shop system."  

The winnings of the casinos eventually amounted to 25 percent of Basicland's GDP, while 22 percent of all employee earnings in Basicland were paid to persons employed by the casinos (many of whom were engineers needed elsewhere). So much time was spent at casinos that it amounted to an average of five hours per day for every citizen of Basicland, including newborn babies and the comatose elderly. Many of the gamblers were highly talented engineers attracted partly by casino poker but mostly by bets available in the bucket shop systems, with the bets now called "financial derivatives." 

Many people, particularly foreigners with savings to invest, regarded this situation as disgraceful. After all, they reasoned, it was just common sense for lenders to avoid gambling addicts. As a result, almost all foreigners avoided holding Basicland's currency or owning its bonds. They feared big trouble if the gambling-addicted citizens of Basicland were suddenly faced with hardship. 

And then came the twin shocks. Hydrocarbon prices rose to new highs. And in Basicland's export markets there was a dramatic increase in low-cost competition from developing countries. It was soon obvious that the same exports that had formerly amounted to 25 percent of Basicland's GDP would now only amount to 10 percent. Meanwhile, hydrocarbon imports would amount to 30 percent of GDP, instead of 15 percent. Suddenly Basicland had to come up with 30 percent of its GDP every year, in foreign currency, to pay its creditors. 

How was Basicland to adjust to this brutal new reality? This problem so stumped Basicland's politicians that they asked for advice from Benfranklin Leekwanyou Vokker, an old man who was considered so virtuous and wise that he was often called the "Good Father." Such consultations were rare. Politicians usually ignored the Good Father because he made no campaign contributions. 

Among the suggestions of the Good Father were the following. First, he suggested that Basicland change its laws. It should strongly discourage casino gambling, partly through a complete ban on the trading in financial derivatives, and it should encourage former casino employees—and former casino patrons—to produce and sell items that foreigners were willing to buy. Second, as this change was sure to be painful, he suggested that Basicland's citizens cheerfully embrace their fate. After all, he observed, a man diagnosed with lung cancer is willing to quit smoking and undergo surgery because it is likely to prolong his life. 

The views of the Good Father drew some approval, mostly from people who admired the fiscal virtue of the Romans during the Punic Wars. But others, including many of Basicland's prominent economists, had strong objections. These economists had intense faith that any outcome at all in a free market—even wild growth in casino gambling—is constructive. Indeed, these economists were so committed to their basic faith that they looked forward to the day when Basicland would expand real securities trading, as a percentage of securities outstanding, by a factor of 100, so that it could match the speculation level present in the United States just before onslaught of the Great Recession that began in 2008. 

The strong faith of these Basicland economists in the beneficence of hypergambling in both securities and financial derivatives stemmed from their utter rejection of the ideas of the great and long-dead economist who had known the most about hyperspeculation, John Maynard Keynes. Keynes had famously said, "When the capital development of a country is the byproduct of the operations of a casino, the job is likely to be ill done." It was easy for these economists to dismiss such a sentence because securities had been so long associated with respectable wealth, and financial derivatives seemed so similar to securities. 

Basicland's investment and commercial bankers were hostile to change. Like the objecting economists, the bankers wanted change exactly opposite to change wanted by the Good Father. Such bankers provided constructive services to Basicland. But they had only moderate earnings, which they deeply resented because Basicland's casinos—which provided no such constructive services—reported immoderate earnings from their bucket-shop systems. Moreover, foreign investment bankers had also reported immoderate earnings after building their own bucket-shop systems—and carefully obscuring this fact with ingenious twaddle, including claims that rational risk-management systems were in place, supervised by perfect regulators. Naturally, the ambitious Basicland bankers desired to prosper like the foreign bankers. And so they came to believe that the Good Father lacked any understanding of important and eternal causes of human progress that the bankers were trying to serve by creating more bucket shops in Basicland. 

Of course, the most effective political opposition to change came from the gambling casinos themselves. This was not surprising, as at least one casino was located in each legislative district. The casinos resented being compared with cancer when they saw themselves as part of a long-established industry that provided harmless pleasure while improving the thinking skills of its customers. 

As it worked out, the politicians ignored the Good Father one more time, and the Basicland banks were allowed to open bucket shops and to finance the purchase and carry of real securities with extreme financial leverage. A couple of economic messes followed, during which every constituency tried to avoid hardship by deflecting it to others. Much counterproductive governmental action was taken, and the country's credit was reduced to tatters. Basicland is now under new management, using a new governmental system. It also has a new nickname: Sorrowland.

Foolishness of Government Spending

From the great team at Daily Reckoning Australia:

And now over to Bill Bonner in Baltimore, Maryland: 

It's true that there are some signs of "stabilization." The unemployment rate is not getting badder as fast as it was a few months ago. And house prices seem to have stopped falling - for the moment.

It's also true that the economy managed to register positive 'growth' in the last quarter... mostly thanks to government spending and inventory restocking.

The trouble is, all of these things are consistent with a depression - especially a depression that the feds are fighting every inch of the way. In the 1930s, there were several years of growth... and there were great years for the stock market too. Then, things fell apart again. The nation ended the '30s not one penny richer than it had been when it began them.

And Japan has seen some good years and some bad years, too, since its depression began in 1990. Oddly, Japan's population is falling... so in per capita terms, Japan's downturn hasn't really been so bad. Per person, the Japanese got richer over the last 10 years.

It's also true that here at The Daily Reckoning, we use the term 'depression' a bit differently than most economists. Most economists believe GDP growth represents increasing prosperity. They think a depression is merely a recession, with negative GDP growth, that lasts longer and goes more deeply than normal.

Our definitions are better:

A recession is a pause during a period of growth. A depression marks the end of the period of growth... giving the economy a chance to make adjustments so that a new period of growth may begin.

GDP growth alone is a fraud. The gross number just doesn't tell you anything worth knowing. It doesn't really matter how fast an economy is growing. What counts is how fast it is growing per person... and whether that 'growth' is real or phony. Growth is not the same as prosperity... Someday, we promise you, modern economists will be ranked below doctors who bled their patients to death and jungle tribes who threw maidens into volcanoes. They are quacks.

These imposter economists think they can fix a recession and prevent a depression. When the private sector stops spending they urge the public sector to step in and replace the missing private spending. That, in a nutshell, is Keynes' theory. A nutshell is the appropriate container. Because there's a world of difference between private spending and government spending. Private spending is voluntary; people choose to spend their money on things they really want. When the government spends, on the other hand, it is merely squandering stolen property. It may look like private spending. But it's not at all the same thing. You can hand out checks to people; it's not the same as when people earn money. You can build bridges and airports too... but they are only valuable to the extent that they are used efficiently. And you can hire all the government employees you want; they don't necessarily add to the sum of human happiness or wealth (most likely they subtract from it!).

Just look at societies that put everyone to work. There was no unemployment in Cambodia under the Khmer Rouge! Or in the Soviet Union. North Korea is another good example today. They all show that putting people to work for the government doesn't make them rich... it makes them poor.

Yet, these modern economists - Martin Wolf at The Financial Times, Paul Krugman at The New York Times, Bernanke, Summers and Geithner in Washington - believe that they can control and cure a depression. All they have to do is to keep the GDP expanding... and keep unemployment from rising. How? Just spend money! The GDP calculators can't tell a phony expense from a real one. Whether the government spends money to do something that is not worth doing... or hire someone who is not worth hiring... or just gives away money to someone who is not worth giving money to... the GDP quants don't know the difference. They think one dollar spent is as good as any other... even if it is a dollar that didn't exist! (Don't get us started on that one... )

And who knows if a job is worth doing? Only the person who pays for it. That's the trouble with government employment; the people who pay the bills don't make the hiring decisions. Modern economists don't even bother to think about it. All they care about is the unemployment rate... not about whether the job is actually useful or efficient. Want to boost the job rate? Easy. Just hire people. Does this make people better off? Of course not.

The Financial Times had a full page in its Wednesday edition devoted to China's empty towns. Bloomberg has been on the story too. It is the story of what actually happens when government meddles in an economy. Last year, China ordered its banks to lend money to infrastructure programs in order to offset the worldwide financial meltdown. The banks responded, doubling their lending. Observers in the West were stunned... and envious. If only we could 'get things done' like that, they lamented. If only our governments had more authority and control over the economy!

But let us go back a year and put ourselves in the shoes of the bankers. They must have had loan requests. Some of them they must have judged worthy of funding, others not. But how was it possible that the number of project deemed creditworthy doubled in the space of a few months? Well, it didn't happen. Instead, the Chinese government merely changed the rules of the game. The banks, under pressure to loan out money, reacted by lending it out... to marginal projects. Now, we're beginning to read about them in the paper - mostly towns without any people. Just wait until China blows up. Then, we'll read about banks without money. Stores without customers. And businesses without a prayer.

China is either going to blow up... or slow down.

Predictions into 2012

I'm agnostic about different cycle systems, but - for what it's worth - the Foundation for the Study of Cycles is predicting:

• Gold will head north of $2000 ounce by the 3rd or 4th quarter of 2011

• This will happen in middle of a sinking stock market and economy

• Other PMs will do well, but not as well as gold

• A major new dollar decline will start in the 3rd quarter of 2010, and end in early 2012 (the dollar's value against gold will plummet)

• A convergence of cycles will make 2012 a total train wreck. For example, the 500 geopolitical cycle will shift, with power and wealth heading from West to East. Other cycles will bottom during the period from late 2011 to late 2012, so things will get really ugly. The 4th quarter in 2012 will be a horrible time for America

Albrechtsen: Big Government - a failed concept

QUICK-off-the-mark media analysis following the dreadful consequences of the Rudd government's home insulation program has focused on the policy and the politicians.

If this was just a matter of amateur behaviour from junior ministers such as Peter Garrett, we could breathe easy that they might at least learn from their mistakes.

But the problem is not just about crude and clumsy policy, or lousy implementation of it, from ministers out of their depth. Nor is it just about a Prime Minister so high on hubris and hypocrisy that he talks about evidence-based policy and then pursues hasty stimulus spending and giant national broadband networks with precious little underlying analysis.

The insulation program is just one example of a bigger problem. It is about political philosophy; about the Rudd government's firming commitment to big government. Here is a textbook lesson in what happens when government throws money at industries they don't understand and have no business being in. In short, we are learning that the bigger the government, the bigger the problems.

RELATED COVERAGE

• Batt Man 'fudging' blaze statisticsDaily Telegraph, 36 minutes ago
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Deservedly so, Environment Minister Garrett has come under sharp attack during the past few weeks. His maladministration of the housing insulation program led to four deaths and more than 90 house fires. It was obvious that a government honey pot of $2.4 billion to insulate 2.7 million homes would attract shonks, fraudsters and untrained workers looking to make a quick buck.

But Garrett's ineptitude is not the core problem. He is part of a government that is, on a number of fronts, committed to interfering in markets with no understanding of the consequences. That firm belief that governments must intervene meant Garrett only requested a copy of a damning analysis of the home insulation program by Minter Ellison 10 months after it went to the Prime Minister's Office and Garrett's own department.

Consider the full consequences. Billions of taxpayer dollars and hasty timetables led to deaths and fires. Government intervention has created an entire new industry of auditors to check 1000 homes potentially electrically alive with foil insulation and 225,000 more homes that could have safety and quality problems. It has also created a new market for electricians sent in to fix the problems who will be tempted to raise their prices in accordance with rising demand for their services. And when the government canned the program last week, thousands of people -- most of them legitimate, trained workers -- were left without work in an industry in limbo until the government's next program commences.

We are watching an eternal lesson unfold: in myriad ways, government intrusion has distorted a market that previously worked well. When government applies pressure to one part of that distorted market, trying to fix problems it created and by replacing the scheme with another, bubbles emerge in other places.

In other areas, too, the Rudd government has, inadvertently, taken us right back to first principles about government intervention. Consider the $14.7bn Building the Education Revolution package to build a new building in every Australian primary school. In the name of stimulus spending to create jobs, tight deadlines have attracted expensive cost premiums from builders and sub-contractors understandably making hay while the government sun shines. Some projects are being done without normal tendering processes, removing normal price competition. Misguided template processes have resulted in some schools getting buildings they don't need. But this is not just about overpriced buildings.

Government interference has distorted the construction market. Any builder doing BER work will tell you, just quietly, that skyrocketing demand for contractors has led to ramped up prices. And when that happens, commercial project planners will look twice before entering the market until prices are more affordable. In other words, when governments step in, others step out.

On ABC1's Insiders program, Communications Minister Stephen Conroy made no bones about the government's big agenda after more than a decade out of office. It is now obvious that the government's "do something" agenda is underpinned by a political philosophy based on big government micro-managing the economy. Its decision to pick winners in the car industry by pumping money into a so-called Green Car is nothing more than an old-fashioned government handout: $43 million to Ford to build a new four-cylinder engine for its cars.

Equally misguided is the government's $43bn decision to fund a national broadband network. The government has not presented a business case, modelling or even a basic cost/benefit analysis. It has no idea about private sector interest or take-up rates by consumers. In other words, no idea about the real cost to taxpayers. Just the firm commitment that government ought to provide broadband in a fast-moving industry where Google in the US is already talking about delivering fibre optic speeds of one gigabit per second, ten

times faster than the 100 megabits promised under the NBN. With the NBN still eight years away from completion, taxpayers may be left paying for out-dated technology due to the government's philosophical bent for an out-dated ideology that has demonstrably failed in the past.

Alas, there is an anathema in some media quarters to dig deeper, to put the government's political philosophy and ideology under the microscope. Echoing Conroy on Insiders last Sunday, the ABC's Fran Kelly complained about The Australian's "campaign" against the government, about the "hard line" it has taken. It was "harder than the Fairfax press", she said. It's called keeping the government accountable, Fran. Perhaps other media outlets could try it.

On the same program, the SMH's David Marr lowered his voice in sinister tones, referring to "that other role" of this newspaper: "the heavy lifting that it does on ideological issues". It's uncanny how ideology is wicked as soon as it differs from the orthodoxy on the Left. This is a timely debate about ideas, David. And history has proven that some ideas are better than others.

We have entered a phase in history where governments increasingly intervene in markets because markets are perceived to have failed. But the insulation program reminds us why we moved to market-based economies in the first pace. Centrally planned economies were even more disastrous. Markets are not perfect but they beat hands-down the enormous distortions created by ham-fisted government regulation.

Keynesian Deathbed

The deathbed of Keynesian economics

MATTHEW LYNN

February 23, 2010 - 12:47PM

Comments 31

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The UK has produced notable economists over the years, but John Maynard Keynes, the guru of government intervention, was one of truly global significance.

So it may be fitting that the UK will also become the deathbed of Keynesian economics.

Britain has been following the mainstream prescriptions of his followers more than any developed nation. It has cut interest rates, pumped up government spending, printed money like crazy, and nationalised almost half the banking industry.

Short of digging Karl Marx out of his London grave, and putting him in charge, it is hard to see how the state could get more involved in the economy.

The results will be dire. The economy is flat on its back, unemployment is rising, the pound is sinking, and the bond markets are bracketing the country with Greece and Portugal in the category marked “bankruptcy imminent.” At some point soon, even the most loyal disciples of Keynes will have to admit defeat, and accept that a radical change of direction is needed.

The public debate about the state of the British economy was enlivened last week by a brawl between economists.

On February 14, a group that included the former Bank of England policy makers Tim Besley, Howard Davies, Charles Goodhart and John Vickers published a letter to the Sunday Times calling on the government of Prime Minister Gordon Brown to control the ballooning deficit.

If it didn’t, the stability of the economic recovery would be threatened, and there would be a run on the pound, they warned.

Keynesian backlash

That brought a stinging response from the Keynesians, who are urging the UK to spend its way out of recession. Nobel laureates Joseph Stiglitz and Robert Solow were among the signatories to letters written by a group of 67 economists insisting that deficit spending was the only way to salvage the economy. The letters, published in the Financial Times, argued that a “a sharp shock” now “would be positively dangerous”.

So who is right, and who is wrong? It’s a debate that matters to the rest of the world. After all, if demand management doesn’t work here, it won’t work anywhere.

The UK has some experience of mass letter writing from Keynes’s devotees. In 1981, a group of 364 economists wrote an open letter ripping into the policies of then Prime Minister Margaret Thatcher. They turned out to be totally wrong, of course. With hindsight, no one can now dispute that her policies led to a long and durable economic revival.

Budget blowout

And just as the Keynesians were wrong three decades ago, they are wrong now.

The UK has been in Keynes overdrive for the past 18 months. The budget deficit is already more than 12 per cent of gross domestic product, on a par with Greece. And while the Greeks are cutting spending, the British deficit is widening.

Figures for January showed another fiscal blowout. At the same time, interest rates have been slashed to 0.5 per cent. And the pound has slumped in value, which is supposed to boost demand for British goods, and help close the trade gap.

Just about everything possible has been done to encourage consumption. The results have been miserable.

Retail sales excluding gasoline in January fell 1.2 per cent from the previous month, twice as much as economists forecast. The number of people receiving unemployment benefits jumped to 1.64 million in January, the highest level since April 1997. The yield on UK government debt is now higher than on Spanish or Italian bonds, a sure sign that investors are losing faith in the country’s ability to pay its debts. The inflation rate has also accelerated to 3.5 per cent.

Triple whammy

In reality, Britain has the worst of all possible worlds: a stagnant economy, a crippling budget deficit and rising prices.

The Keynesian consensus is that things would have been far worse without the stimulus provided by government. And if the economy isn’t pumped up with inflated demand, it will collapse back into recession. If it’s not working, that just proves the stimulus should be even larger.

It is the argument quacks always push: if the medicine isn’t working, increase the dosage.

And yet, reality has to intrude into this debate at some point. The deficit can’t get much bigger, interest rates can’t be cut much lower, and sterling can’t lose much more value.

Stimulating the economy isn’t working.

In fact, it’s only making it worse. Consumers and businesses don’t want rising taxes. A falling currency pushes up the cost of everything the UK imports, stoking inflation. Savers get decimated, and yet the banks remain reluctant to lend because they rightly believe the economy is in the doldrums.

Recipe for recovery

What’s needed is a total change of direction. Get the deficit under control. Raise interest rates to restore confidence in the pound, and reward saving. Cut taxes to stimulate enterprise and investment.

And yet the real lesson of the UK in 2010 will be of wider significance. A country can’t spend its way out of a recession. And it can’t fix what was at root a problem of too much debt by just borrowing more and more.

In the country of its birth, Keynesian economics is being tested. If the economy isn’t growing at a healthy clip again by the end of 2010, its failure will be obvious to everyone.

Matthew Lynn is a Bloomberg News columnist. The opinions expressed are his own.

Bloomberg