American Junkies

I do not think that many in the “hard money” school understand that cutting government spending in the short term will harm the economy. By definition, a part of GDP is government spending.

 GDP = private consumption + gross investment + government spending + (exports − imports), or

 

So in a 15 trillion dollar economy if government spending goes down by the amount of the deficit, 1.3 trillion, the economy contracts by 1.3/15, or by 8%. This will not be good. But before we reject cutting the deficit we need to consider what will happen if we don’t.  

I predict 2 to 7 years left. Our economy since 1913 is like the heroin addict injecting more and more heroin to get the same high as his body becomes used to the drug. The Federal Reserve, with the exception of the Volker years, gets the US economy out of the doldrums by bigger and bigger deficits. Sooner or later there will be an overdose. Isn’t it better to go off the junk, even if it is painful? Isn’t pain better than death? Make no mistake—economic death is where we are headed. 

In this election cycle there are three approaches. 

Obama is in denial. Like the relative who notices the various signs of heroin abuse, weight loss, erratic behavior and so on, but denies that there is a problem, Obama is ignoring all the signs of an imminent collapse of the system. I suppose it is possible that the observable signs will stop, but as long as the behavior continues, so will the effects. Death is the ultimate outcome. As I have been saying, quoting George Shultz, what can’t continue won’t. 

Romney, by adopting a version of the Ryan plan, seems to be advocating the methadone approach. 

Methadone is useful in the treatment of opioid dependence. It has cross-tolerance with other opioids including heroin and morphine, offering very similar effects and a long duration of effect. Oral doses of methadone can stabilise patients by mitigating opioid withdrawal syndrome. Higher doses of methadone can block the euphoric effects of heroin, morphine, and similar drugs. As a result, properly dosed methadone patients can reduce or stop altogether their use of these substances.

By using methadone, the heroin addict can gradually wean themselves off heroin. This approach has the deficits continue but they get gradually smaller as spending growth is ratcheted down. 

The Governor Johnson approach, Johnson is the libertarian candidate, is to, to continue my heroin analogy, go cold turkey. Cut spending by 43% immediately and get the pain over with. Only after this is done can the economy grow. Sometimes “cold turkey” works, but it is very risky for the patient. Close supervision is needed. 

My own approach is between Romney and Johnson. Yes I know that is a fourth approach, but I am not running for office, and no one is really interested in my approach. I would cut spending by a lot, but less than Johnson. I would increase taxes by letting the Bush tax cuts expire.  Then, to avoid the crash, I would have a very large quantitative easing for several years. Yes, I, as a “hard money” guy am proposing printing a lot of money. I am ashamed. But we do not live in an ideal world of theories. We live in a real world and need to be pragmatic. 

My guess is that since all politicians are liars that Obama will actually adopt the Romney approach when he is reelected. If Romney is elected he will cut spending even more than he is saying. What about Johnson? The only way Johnson can get elected is if Romney and Obama get caught in bed together with a goat. 

I realize this is very optimistic. It is possible that Obama is in fact as clueless as he appears. One of my favorite sayings is “Never underestimate the power of stupidity.” Surely Obama and Romney can’t be that stupid? Surely? 

Remember the old Chinese Curse? 

May you live in Interesting Times.