Crescenzi: “The Keynesian Endpoint”
Senior VP, Strategist, Portfolio Manager Pimco
After Lehman fell, the scope of the financial crisis became so great that the fiscal and monetary authorities throughout the world possessed the only balance sheets large enough to resolve the crisis. In essence, the ills of the private sector were set to shift to the public sector. The sense at the time was that it would work; after all, the borrowing ability of the United States and the rest of the developed world were proven, and the ability of central banks to print money was and remains indisputable. Nevertheless, there was a sense of discomfort in the supposed solution.
In articles I wrote in 2008, I posed a question, calling it the question of our age: If the U.S. is backing its financial system, who is backing the U.S.? The basic premise rested on the idea that efforts to stabilize economies and markets looked likely to work if investors tolerated the additional debt the efforts required. If not, there would be financial Armageddon. The direst outcome was of course avoided, but dark days have returned to some nations and are threatening to return to the world at large because the solutions themselves are being seen as a magic elixir that has morphed into poison.
As we are seeing again of late in Ireland and Greece in particular, nations have reached the Keynesian Endpoint, where there are no more balance sheets left to support either economic activity or the financial system.
This is not literally true but true in practice because investors at the present time have no tolerance for either fiscal profligacy or the monetization of deficits by the world's central banks.
Nations are left with old playbooks and fewer choices by which to resolve their respective problems. This means that time, devaluations, and debt restructurings might be the only way out for many nations. It also means the citizenry will require politicians that can think outside of the box and act with greater unity and resolve than perhaps they are used to.
Not Enough Jam to Fit the Size of the Pill
In his classic book "The General Theory of Employment,"John Maynard Keynes describes why he believes fiscal stimulus produces job growth. He theorizes that the marginal propensity to consume, which measures the proportion of increased spending expected to result from each unit of change in income, is far closer to 100 percent than it is to zero. Hence, with people more likely to spend rather than save, this therefore means that there is likely to be a multiplier effect from government efforts to stimulate economic activity, resulting in an increase in the total level of employment.
The impact that the current deleveraging process might have on the marginal propensity to consume begs the question: can the world's fiscal authorities, having reached a point where the private sector's want, need, and in many cases only choice is to reduce debt and hence the desire to consume, rationally expect that by ever-increasing their amount of public borrowing they can reduce the total amount of unemployment in any manner that even remotely resembles the way they were able to in the past? Suppose as they might, this scenario seems implausible.
The bottom-line is that the fiscal authority must recognize that the deleveraging process will limit the effectiveness of new fiscal stimulus. The decrease in the marginal propensity to consume, which is evidenced in the extraordinary decline in consumer credit, as well as the rising U.S. savings rate shown below, weaken the multiplier effect and make it unreasonable to assume that fiscal stimulus in an age of deleveraging will boost private spending in the same fashion as it has in the past. This is in addition to the idea that there are no more balance sheets to fund the stimulus.
The harsh realities of the Keynesian Endpointput academicians, politicians, and opinion writers in a cloister, where their collective voice and influence will be engulfed by others who recognize the existence of the Endpoint. Intransigent Keynesians will be overwhelmed by a majority of people having the good sense to know that they must embrace fiscal austerity and the other remedies required to avoid the societal harm that comes from excessive indebtedness. Those that refer to historical examples where fiscal stimulus worked and then combine this with the idea that today's low level of market interest rates show how little there is to fear about increases in government indebtedness do so with contempt toward the financial crisis and its profound message about overleveraged societies.
Some nations will find the Holy Grail and seek out more efficient means of stimulating economic growth. Others will be intransigent, clinging to their Keynesian ways and in the process fail to take measures that restore fiscal stability. These nations will be forced to devalue their currencies, restructure their debts, and henceforth put at risk their growth rates in productivity, the lifeblood that improves a nation's standard of living.
"The Keynesian Endpoint" is the title of my fifth book.I recently wrote a digital short for the book.
Tony Crescenzi is Senior VP, Strategist, Portfolio Manager Pimco. Crescenzi makes regular appearances on financial television stations such as CNBC and Bloomberg, and is frequently quoted across the news media. He is also the author of "Investing from the Top Down," "The Strategic Bond Investor," and co-author of the 1200-page book "The Money Market."