Faced with bailout or collapse, should US choose collapse?

Stocks were flat yesterday. Gold fell $3.

The news was mixed.

The big debate is between those who think the authorities are being too tight and those who think they are being too loose. Broadly, Europeans are on one side. Americans are on the other. The Europeans are tightening up. The Americans are letting rip. They’re both wrong, as far as we’re concerned.

It’s all nonsense. Just goes to prove our dictum that people come to think what they must think when they must think it. The Euro-feds can’t afford to think they can loosen up. Their lenders have already laid down the law: ‘Keep spending like the Greeks and we’ll hit you with Greek-style interest rates.’

Just a few weeks ago the Greeks were forced to pay 16% interest. At that rate, borrowing is out of the question. You’re effectively cut off. Because the more you borrow, the higher your interest rate. Soon, you run out of money.

As Nouriel Roubini put it, ‘austerity is not optional.’ Since it’s not an option, but a necessity, there’s no point in thinking anything else. You might like to spend more money, but you know you can’t get away with it.

The US doesn’t have to think about austerity. Not yet, at any rate. They’ve got the whole world ready to lend them money. ‘Here, take a drink of rice wine,’ say the Chinese. ‘Here is some champagne,’ say the Europeans. ‘And here’s a bottle of whiskey,’ say the jokers in the back of the room.

It is only a matter of time before Americans fall down.

Not so, say the Keynesians – led by Paul Krugman and Martin Wolf. They say it’s just a matter of managing the situation. Enjoy the party. You can pull yourself together later.

“The best policy is to put together measures that sustain strong growth in demand in the short run,” writes Wolf in yesterday’s Financial Times, “while constraining the huge deficits in the long run. It’s like walking and chewing gum at the same time. Why should that be so hard?”

Meanwhile, Richard Koo probably knows more about this sort of economy than anyone. He’s lived with it in Japan for the last 20 years. So, what does Koo think?

He says you can forget about a quick recovery. Japan has been hoping for a quick recovery for the last 20 years. It’s been following the Krugman-Wolf approach – stimulating demand with fiscal policy. That is, it spends more than it collects in taxes, counting on the extra government spending to light a fire under the private sector.

But that won’t happen, says Koo. The private sector won’t start spending again until it has finished de-leveraging. Paying off debts takes a long time – especially when the government keeps bailing you out. So prepare for a long slump in the private sector economy.

So far, so good. But then Koo takes the classic Keynesian line. Like Krugman and Wolf, he believes the government should replace private spending with spending of its own.

It sounds logical enough. At least if you don’t think about it too much. An economy is the sum of spending and investing. If the private sector goes into a funk and stops spending and investing, the economy shrinks. So why shouldn’t the government step in and help out a bit?

Koo thinks so. Krugman, who won a Nobel Prize in economics, thinks so. Wolf, who heads up the worlds’ most influential financial journal, thinks so.

Well, count on us, dear reader. We don’t think so.

A real economy is much too complex for such simpleminded management. It is an organic system that delivers to people what they want (markets give them what they deserve). An economy doesn’t necessarily correspond to what academic economists think it should be…or necessarily do what they think it ought to do…or sit still long enough so they can tell what the hell it is doing.

A real economy has a mind of its own. It doesn’t care about their GDP growth rates. Whether people lose their jobs or not is not its problem. And it certainly doesn’t intend to help politicians get re-elected.

Sometimes people want to spend. Sometimes they want to save. Keynes identified this “propensity to save,” as though it were an unpardonable sin. If the people won’t spend, we’ll spend for them, he said…or words to that effect. But why shouldn’t people be allowed to save money rather than spend it?

‘Because the economy might collapse,’ says the Krugman-Wolf-Koo crowd.

‘So what?’ answers The Daily Reckoning.

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