Strong opinions, weakly held

One case against further stimulus

If you, like me, read a lot of liberal blogs, you see people arguing every day that the best thing the government can do right now is spend more money to stimulate the economy and restore economic growth. For example, it’s become clear that the spending in the stimulus bill in 2009 has been offset fully by the contraction in government spending at other levels that resulted from falling tax revenues. And the general argument is that as long as interest rates are low for government bonds, we should take advantage and borrow money to prop up the economy. I find this argument persuasive, so I’m on the lookout for solid counterarguments.

Analyst John P. Hussman, in a long (and important) article arguing that the economy is not really in recovery and that the worst is yet to come, describes a pattern that we’re seeing right now:

From an inflation standpoint, is important to recognize the distinction between what occurs during a credit crisis and what occurs afterward. Credit strains typically create a nearly frantic demand for government liabilities that are considered default-free (even if they are subject to inflation risk). This raises the marginal utility of government liabilities relative to the marginal utility of goods and services. That’s an economist’s way of saying that interest rates drop and deflation pressures take hold. Commodity price declines are also common, which is a word of caution to investors accumulating gold here, who may experience a roller-coaster shortly. Over the short-term, very large quantities of money and government debt can be created with seemingly no ill effects. It’s typically several years after the crisis that those liabilities lose value, ultimately at a very rapid pace.

Reinhart and Rogoff continue, “Episodes of treacherously high inflation are another recurrent theme. Indeed, there is a very strong parallel between our proposition that few countries have avoided serial default on external debt and the proposition that few countries have avoided serial bouts of high inflation. Even the United States has a checkered history. Governments can default on domestic debt through high and unanticipated inflation, as the United States and many European countries famously did in the 1970’s.

“Early on across the world, the main device for defaulting on government obligations was that of debasing the content of the coinage. Modern currency presses are just a technologically advanced and more efficient approach to achieving the same end. In many important episodes, domestic debt has been a major factor in a government’s incentive to allow inflation, if not indeed the dominant one. If a global surge in banking crises indicates a likely rise in sovereign defaults, it may also signal a potential rise in the share of countries experiencing high inflation. Inflation has long been the weapon of choice in sovereign defaults on domestic debt and, where possible, on international debt.”

This is why many smart people are talking about inflation even though we’re currently experiencing deflation. On one side, we have the risk of inflation or default down the road if we keep borrowing money now. On the other side, we have the risk of a deeper, more painful recession and less economic growth down the road if we go with austerity. And we have two parties in Congress who are making decisions about what to do based on their immediate political future rather than the long term interest of the country. We are so screwed.


  1. Yes, a permanent depression as in Japan or the late 19th century is far superior to potential future inflation. Unfortunately, government borrowing is the only way out of a depression, at least on this planet, so we are seriously screwed. Having lived through the 1970s with their rising wages, prices and interest rates, all I can say is thank god Ronald Reagan broke the back of the American worker so that now two adults have to hold jobs to maintain the same life style that one worker could afford during that horrible era.

  2. As I’ve said a number of times, I’m betting fairly strongly on inflation. However, that leads to a question: Why are those who are willing to take the other side of that bet (ie: helping me to refinance to a 5% 30 year fixed mortgage) still doing so?

  3. @Dan, short term the 5% is better than ~0%. And most mortgages don’t last the full term (7 years is the average IIRC). It’s unlikely that we will have inflation rise quickly, it will just rise and be above the long term average for some number of years, so as long as the 5% mortgages are unrolled 5+ years out, I suspect it’s a “relatively safe” investment.

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