Posted by: michaeldavidpower | November 1, 2011

Adding more fuel does not mend a flooded engine!

Adding further fuel to the tank when the economic engine is flooded does not solve today’s problem in the West. Policy makers have left the choke of stimulus out for so long, the engine is drowning in liquidity and so misfiring badly. In Japan’s case, it has hardly fired in two lost decades. Welcome to the “New Normal”. As impotent as this might make policy makers feel, more of the same, more fiscal and monetary accommodation, would not be the right solution given this diagnosis.
Traditional Keynesians might not acknowledge this but there is not enough scarcity in the West today for Western capital to engage profitably in investment – cash-flush US Inc is testament to that.
I am drawn to an “off-centre” debate Piero Sraffa tried to have with Keynes in 1932, one which was brushed aside in the dark days of the Great Depression but which – as none other than Joan Robinson feared might happen – has now come back to haunt the West. Sraffa was grappling not with the idea of insufficient demand but excess supply. As Robinson wrote to Keynes:
I think that, like the rest of us, you have had your faith in supply curves shaken by Piero. But what he attacks are just the one-by-one supply curves that he regards as legitimate. His objections do not apply to the supply curve of output as a whole – but heaven help us when he starts thinking out objections that do apply to it!
Sraffa never concluded his line of thinking but perhaps the “supply curve of output as a whole” has finally caught up with – and overwhelmed – today’s West. Perhaps using fiscal and monetary stimulus to goose demand has reached the limits of its effectiveness leaving Western economies trapped in the vice between their bond market’s growing reluctance to finance the accumulated detritus of decades of near-permanent pump priming and worsening Western demographics, where those obliged to pay for those accumulated debts are noticeably declining in number.
Current fiscal and monetary stimulus generates increasingly unprofitable demand in that it yields a price for goods and services lower than the level required to cover the costs incurred in making those goods and services including, critically, the non-cash cost of capital charge. Exhibit A: the US Auto sector; exhibit B: the US Airline sector. This means huge swathes of the Western economic landscape are commoditizing because of oversupplied product that cannot be sold at a true profit.
Sraffa’s ghost would today likely be pointing at the abundance generated by aggregate supply, not insufficient aggregate demand, being the root cause of the West’s current problems. Abundance? It was Keynes’s insight too, for he too noted that the root cause of the 1930s was a supply one: “We should have it at the back of our heads that this is not a crisis of poverty, but a crisis of abundance.”
Perhaps Keynes’s 1930s solution – to goose aggregate demand by using the fiscal choke to jump-start the engine of growth again – was indeed the right “just-do-something” approach then. But the West and Japan have been running that engine full throttle and with the choke out ever since. And now their economic engines are flooded and vast sectors of their industrial landscape commoditized.
With today’s much higher accumulated levels of national debt, much higher levels of government expenditure as a share of GDP and far worse demographics, more fiscal and monetary spending in today’s context rewrites Einstein’s definition of insanity: doing the same thing again and again and expecting the same result… even when the background conditions are materially different.


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