Paul Krugman: Big Government Prevented Second Great Depression
New York Times columnist and economist Paul Krugman won the Nobel Prize for economics in 2008, primarily for his work in the areas of international trade and economic geography. He recently wrote this interesting article.
He makes a case, with caveats, that three factors saved us from a second depression: 1. government spending in the face of falling revenues 2. rescuing the financial sector 3. the American Recovery and Reinvestment Act (the Obama Stimulus Plan).
Three things initially struck me about the article: 1. Why did Krugman make no mention of the dangers of our budget deficits and national debt? 2. Has Krugman considered the possibility that the rescues and spending could prolong the economic downturn, especially if it leads to killer inflation and/or loss of our AAA credit rating? 3. I’m not as confident as Krugman that we have avoided a second depression, as I’ll cover in my portfolio update at the bottom of this blog.
After digging around on Youtube, I did find this clip of Krugman discussing how much debt he thinks this country can handle. I now have a theory as to why Krugman isn’t too concerned about the issues I raised. Incredibly, I don’t think he’s considering Social Security and Medicare entitlements when estimating the viability of our future debt-to-GDP ratios! Is this possible?
Note that at 2:50 in the video, he makes the statement that “Deficits do matter but we have 5-6 trillion dollars to play with here.” How do we have that kind of money to “play with” when you consider the trillions of entitlement debt?
Can a Nobel prize winning economist really be ignoring tens of trillions of dollars in debt? It seems hard to believe.
Bill Gross founder of Pacific Investment Management Company has a very different view from Krugman, as quoted in this Bloomberg article. Look how much estimated debt-to-GDP ratios change when entitlements are considered.
From Bloomberg: “Gross, manager of the world’s biggest bond fund, said on May 21 the U.S. will ‘eventually’ lose its AAA credit rating after Standard & Poor’s lowered its outlook on the U.K.’s AAA to ‘negative’ from ’stable’ amid an escalating ratio of debt- to-gross domestic product. While U.S. marketable debt is at about 45 percent of GDP, annual deficits of 10 percent will push the amount to 100 percent within five years, a level that rating companies and markets view as a ‘point of no return,’ he wrote.”
“The U.S. growth rate ‘requires a government checkbook for years to come,’ Gross wrote. Coupled with Medicare and Social Security entitlements, government borrowing could reach 300 percent of GDP, meaning ‘the Chinese and other surplus nations cannot fund the deficit even if they were fully on board,’ he wrote.” (Bloomberg)
For an illustration of how important entitlements are when estimating debt-to-GDP ratios, please check out this clip from the Glenn Beck show.
Quote of the Week:
“We’re going to go bankrupt as a nation. Now, people when I say that look at me and say, ‘What are you talking about, Joe? You’re telling me we have to go spend money to keep from going bankrupt?’ The answer is yes, that’s what I’m telling you.”
~Joe Biden, speaking during an AARP Town Meeting in Alexandra, VA (here’s a link to the video).
Portfolio Update:
I’m not sure we’ve reached the bottom of this downturn. I’m still standing by my prediction of Dow 5,500 or lower.
And don’t worry, I’ll still take credit if there’s a big terrorist attack or H1N1 flu outbreak that helps tank the economy.
I believe we will have another market downturn within weeks or months, so I’m still being very cautious.
For now I’m holding core positions in IShares Silver Trust (SLV) and SPDR Gold Trust (GLD). I’m also trying to trade around the ups and downs of silver and gold.
In addition, I have a position in Agnico Eagle Mines (AEM) and a position in Federated Prudent Global Income Fund (PSAFX).
I’ve taken a horrible hit on my speculative position even though it’s more than doubled since the first of the year. Broadwind Energy (BWEN) manufactures wind turbines and are one of the purest wind plays around. ‘
Shortly after I bought it at around 27 bucks, Jim Kramer said on his Mad Money show, “Broadwind’s going to 40.” It never reached 40 but tanked instead. For a while there I thought that rascal meant 40 cents instead of 40 bucks!
Buried News of the Week
Are compulsory H1N1 Flu Shots Being Planned?
Some of us are old enough to remember the swine flu shots of 1976. If shots are being planned, I hope they do a better job this time. (In ‘76, over two dozen people died from the vaccine and the vaccine turned out to be unnecessary.)
See you next time!
August 12th, 2009 at 6:29 pm
Good blog Aaron! I am curious. How does the AAA rating play into all this? Why does it matter? I also like the quote of the week and portfolio update. It will be interesting to see if a swine flu outbreak tanks the economy and if the shots do become compulsory.
August 13th, 2009 at 3:30 pm
The AAA rating is important because it tells investors that they can have a high degree of trust that the U.S., or any country with the rating, won’t default on their bonds. If we lose that rating, the Fed and the Treasury will have to crank up the interest rate in order to sell their bonds. Even if we did that, we could also lose the big investors like China.
If we reach a point where we can’t sell our debt when we have already massive debt, that could lead to a vicious cycle. If that happens, I could see Social Security recipients getting ripped off or other nasty things happening. I wouldn’t want to be depending on the government over the next few years.
Also like Bill Gross alluded to, if our debt-to-GDP ratio gets high enough, like the 300% mentioned, the Chinese wouldn’t be able to fund our debt even if they wanted to. They just wouldn’t have enough money to do it.
If Swine Flu doesn’t mutate into a more deadly form, or we have an effective vaccine, our economy should be safe on that front. I just don’t think we have any guarantees.
Thanks for the comments!