Cookie policy
Follow this topicFollow this topic Knowledge » The economy

Obama understands how to cut a deficit, I think

Ed Bowsher
by Lovemoney Staff Ed Bowsher on 07 September 2010  |  Comments 17 comments

Big spending cuts won't reduce the deficit.

I’ve said several times that I think George Osborne’s strategy of aggressive spending cuts is a mistake. But I haven’t written much about what is going in the US. That’s a mistake, hence today’s post.

Let’s start with a quick recap of the history. Early last year, Obama launched a $787 billion stimulus package that was designed to head off a depression after the financial crisis. The money was mainly spent on infrastructure projects and support for state governments that weren’t able to borrow in tough times.

Polling evidence suggests that a majority of Americans think that the stimulus hasn’t worked. I think there are two reasons people for this:

-          Unemployment has stayed high. It rose to 9.6% in August and many pundits think it could go over 10% next year

-          The Republicans and their friends in the media have worked very hard to spread the false message that the stimulus has done nothing except increase the deficit.

It’s my strong belief that the US economy would be in a worse mess without Obama’s package and that the deficit would be higher too. If you don’t believe me, check out this blog post by Paul Krugman in the New York Times and, in particular, the graph at the bottom.

It’s just a shame that the package is now running out of puff and that unemployment is set to rise. It looks like Obama understands that he should have gone for a bigger stimulus and is trying to correct his mistake to some extent. He’s proposing to set up an ‘infrastructure bank’ and spend $50 billion on improving road, rail and other infrastructure.

Why does that matter to us?

I only wish Obama felt able to do much more but I guess he’s constrained by political realities and what he can get through Congress. It’s important for all of us that he makes progress on this because a healthy US economy is very much in the interests of the UK. If the US is struggling, it’ll be harder for our exporters to make money there.

Even more importantly, I wish George Osborne would pay attention to what Obama is doing and switch strategy.

It’s frustrating that Obama hasn’t gone for a bigger stimulus. We don’t know whether his limited proposals are driven by a realistic acceptance of political reality or whether he genuinely believes that a larger stimulus would do more harm than good. My hunch is that it’s the former. Either way, he isn't pushing for an Osborne-style austerity package. He probably understands that would be a very dumb move.

More: This speech is well worth reading

Enjoyed this? Show it some love

Twitter
General

Comments (17)

  • Landlord
    Love rating 15
    Landlord said

    Let's be honest here: nobody knows for sure whether it is better to artifically 'stimulate' the economy with massive new infrastructure spending by borrowing more from overseas countries (mainly China & Middle East) OR to cut back on expenditure and live within our means. In the Great Depression governments did the latter and eventually climbed back to economic success. The former hasn't been tried in a big way until now so we do not yet know the consequences of massive stimulation.

    Clearly if the US borrows too much, foreign creditor nations will demand higher Treasury bond yields which could create a vicious cycle of increasing indebtedness for the US. In the worst case scenario the US might even get itself into a default situation on Treasuries - unthinkable until now. China, the largest lender to the US, has already expressed concerns at the level of US indebtedness.

    I do not know - but I THINK the UK approach seems to be the prudent one. 

    Report on 10 September 2010  |  Love thisLove  0 loves
  • brumont
    Love rating 0
    brumont said

    If we were starting from a balanced budget position then the author's position would have more credance. As it is, we have been running an increasing deficit for years, which has effectively been a stimulous package. Now is the time the line must be drawn, but I do hope the Government will be a little more selective in what they intend to cut. I for one would take a small percentage out of the large budget in the NHS which would reduce the need for draconian cuts across SOME of the other services.

    Report on 10 September 2010  |  Love thisLove  0 loves
  • Mick James
    Love rating 25
    Mick James said

    What makes you think there's a "right" answer? Even if we end up in an appalling state after four years of cuts from Osborne, that doesn't mean that we'd have necessarily been better off following the stimulus route. We might be equally badly off, just in a different way.

    The problem with the stimulus approach is that it's a one-way bet on things returning to "normal" when it's clear that the global economy is in transition. What's healthy about an economy which shows outward signs of growth but turns out to be only kept alive by borrowing and public sector employment. Western lifestyles have long been predicated on us having higher incomes than other people for doing basically the same or less work. That period is rapidly coming to a close. Do we bite the bullet now, or keep on borrowing?

    We have had a stimulus, and look what it's achieved--very little. Is the failure of a policy automatically a call to do it again only more so? And was a continued stimulus ever on the table?

    Darling's pre-election budget was only a holding exercise, and even he had promised to cut "deeper than Thatcher". So it was really only ever a question of how far and how fast to cut. My personal view is that Darling would have had to change his tune and cut faster after the election in the face of the sovereign debt crisis, and that on the other hand the Coalition's goals are overambitious. So we're probably getting pretty much what we would have had whatever the outcome of the election.

    Report on 10 September 2010  |  Love thisLove  0 loves
  • UpHillAllTheWay
    Love rating 38
    UpHillAllTheWay said

    There is a third line that is missing from the graph in the other article referred to - the GDP itself. It can, however, be inferred. For deficit to have come down as a proportion of GDP, while the deficit was still rising, then GDP must have gone up like a rocket. Is that likely to happen in the UK?

    We have all seen what the conditions are in economies that are "doing well". China, at the moment, is doing very well, with a growth rate that is enviable by the rest of us, but what is the standard of living like for the mojority of Chinese? Same in India. When Britain was the centre of an empire, and "doing well", it was the manufacturing centre of the empire, and people were proud to say they were British - but huge numbers of people were working draconian regimes in the cotton mills, or living in work houses, etc. There were a minority of very rich people in stately homes, but the majority were poor, working long hours for a pittance. Japan saw the same vertiginous rise during the 60's, after the war, but when everybody started to enjoy the results of the growth, and Japanese tourists were everywhere with their expensive cameras and tour busses, their economy started to do not so well - a bit like ours, when the standard of living rose for the average person, at the end of the empire.

    It seems to me that there is a limit to how well people can live and keep their nation's economy healthy - and I think we have probably been living a bit too well during the Brown years of borrowing.

    If my teenage son was maxed out on his credit card and was struggling to pay the monthly payment, I wouldn't encourage him to "solve" it by getting another credit card! Our spending has to be reduced, and I think the government is doing the right thing. Sure, our average standard of living will fall, and that will hit me, on the point of retirement, as much as much as the majority, but it may stop the national debt from spiraling out of control. 

    Report on 10 September 2010  |  Love thisLove  0 loves
  • Mike10613
    Love rating 600
    Mike10613 said

    You and your colleagues in London can max out your Santander credit cards, stimulate the economy and the rest of us will keep on with the frugal living and when inflation and high interest rates hit; we will survive. Will you survive when mortgage rates are no longer subsidised by savers enduring pathetic interest rates. When banks have to compete for savers deposits again; we will see sensible economics. 

    Councils are cutting down where I live, the garbage collectors are working to rule because of a pay cut. They can afford to give us all a nice new replacement wheelie bin to recycle. Now we have a bin for garbage, one for garden refuse and one for recycling. 

    I had an email this week from the local PCT, yes we are now stakeholders and they want our support now their overpaid jobs are on the line! The time to cut all the bureaucracy and politically correct nonsense was before it sent us into recession and the Americans waste on a 24/7 basis. Go around any American city at night and look at those tower blocks. The lights are on - but no one is home. 

    We don't want to copy America any more, we need to start with government, cut waste, turn off computers and lights at night. Regulate banks and commerce - they can't and won't regulate themselves. Don't listen to the economists from the London school of economics; if they were any good we wouldn't be in this mess. 

    This government may be a bit clueless but at least they are cutting some waste. We may get some essentials cut too, that is the price you pay for a spend, spend, spend mentality. 

    Incidentally, Clegg said he would listen, he is only accepting emails from constituents now; quick change as soon as he got a little power. There will be another change when he loses that power; we ain't stupid! 

    Report on 10 September 2010  |  Love thisLove  0 loves
  • shikisha
    Love rating 3
    shikisha said

    May I mention to Uphillallthe way that his view of Britain before the 39-45 war is quite wrong. I'm 85, 2 years younger than the BBC. Here are some facts aboujt the 30s, so often quoted by leftwingers as a time of extreme hardship, when the poor were ground down by the rich. 

    In the three years 37, 38 and 39 more than 500,000 houses annually were built in Britain. In 1939 British motor manufacturers supp;lied 90% of the market and sold 350,000 vehicles.

    My father worked as a clerk in the Royal Arsenal Coop Society in South London. He was also the unpaid rep of his union then called USDAW. On a salary of just under £150 a year he bought a house for about £600. He of course was the sole breadwinner - quite usual at that time. That same house was sold a year or two ago for £180k.

    To keep the same ratio of income to price, a single buyer today would need a salary of £45k.

    Take a look round the suburbs of London and you can see millions of houses that were bought by average working people. The same group today can buy such houses only on a joint salary. And with the explosion of population that is crushing London, not only will that balance worsen, new flats and houses are shrinking in space like Victorian tenements, with tiny rooms.

    HOIw did we live? We always had a seaside holiday. When my brother and I were older and could be left with grandparents, my parents had a week's holiday in a resort in Belgium.

    And I'll give you a crucial differnce in the financial state of the country, as described in an article by Maynard Keynes in 1931.

    IN 1931 Britain received interest payments of £100,000,000 a year - £3bn in today's money

    In 2010 Britain will pay out approx £40 bn interest.

    Britain fared better than any other country in the crisis of the 30s. THe OECD has just reported that Britain will come out out top in the modest growth forecast for the next few years, THis could be damaged by Obama's reckless spending, on top of US huge 'defence' costs.

    How soon before the dollar ceases to be top reserve currency? Imagine CHina unloading its huge dollar holding - what will happen to oil priced in dollars? What will happen to world trade?

    Glib politicians falsely claim that this Keynesean policy must be folllowed.

    I believe that he would shudder at the thought. It's like generals who always disastrously try to fight wars with the strategy and tactics of the war before last.

    Report on 10 September 2010  |  Love thisLove  0 loves
  • maarkyboy
    Love rating 10
    maarkyboy said

    Brumont. You need to know the NHS doesn't have enough cash to maintain a good supply of clean laundry. You want to cut the budget or maybe you are just fishing for a reaction

    maarkyboy (retired RGN)

    Report on 10 September 2010  |  Love thisLove  0 loves
  • UpHillAllTheWay
    Love rating 38
    UpHillAllTheWay said

    I agree with what Shikisha says - though she is referring to a period at the end of empire, when the standard of living had risen to resonable levels, and was still rising. That was not the era of the cotton mills and the work house - yet it was in that era, in the early days of steam, that Britain was becoming great. The standard of living was still improving in the late Victorian era, and continued to improve till now in some ways, but the decline has already set in, with smaller rooms and higher prices as noted by Shikisha. The period I was referring to was earlier than that - while Britain was still improving to the point where it was in Sikisha's day.  My Dad was on about £8/10 a week when I was 4 yers old, running a car, buying a house in Carlisle, and taking the family on an annual (modest) holiday.

    But Sikisha also brings out that Britain was the recipient of interest on loans to other nations. Now, it is paying interest on its loans. So what happened? The national surplus turned into a national debt - because we spent it on improving our standard of living, and when it was all gone, but we were addicted to the standard of living, we borrowed to support it. The NHS is a fine institution, but when it was set up, it was paying for much more basic care than it is now. People then only expected that it would supply nurses and hospital beds, and operations that used tools that were very cheap and unsophisticated compared with now. Body scanners, laser eye machines, etc are immensely expensive - but now, we all expect the best - so the NHS is much more expensive than it used to be - but health care is an important part of that rise in the standard of living.

    She's right about the global economy too, and America's effect on it. I think it all started with Ronald Regan, who took the world's greatest creditor nation and turned it into the world's greatest debtor in a few short years by borrowing, and bringing about a huge "fiscal easing" in the belief that people would use it wisely and build up the nation's output. Of course, they used it to have a good time. You'd have thought that Gordon Brown would have learned sometning from that!

    Imagine, for a moment, the graph of nationsl surplus turning into debt - a line sloping downwards - then project it into the future. What's going to happen? If the deficit was zero, then the debt would stabilise - but what we are talking about is reducing the deficit. If we want to reduce the national debt, the deficit has to go to a surplus. So what can push that graph line up again? To me, it seems that only an increased GDP can do it - but that means people producing more for the same, or accepting less for the same production. Where will we be in 50 years? It won't concern me, but for the sake of my two children, I hope my beliefs are wrong.

    Report on 10 September 2010  |  Love thisLove  0 loves
  • wally144
    Love rating 26
    wally144 said

    The first mistake was to bail out the banks. The ones in trouble should have been allowed to go to the wall. I know that this would have resulted in some serious problems for the country, but after the dust had settled, the surviving institutions (HSBC, Lloyds [if they hadn't bought HBOS - encouraged by the government], Nationwide, and a couple of other medium sized banks) would have picked up the worthwhile assets of the fallen banks and the country would have weathered the correction which inevitably followed. We wouldn't have needed to borrow more money or print it for that matter. The country would have emerged stronger for it.

    I agree with the current governments efforts to balance the budget. They won't complete this, but they will reduce the deficit. Large areas of the administrative machinery of government are bloated with too many uneeded staff. The NHS should not be ring-fenced either - it has its share of redundant managers, and non-jobs.

    I despair that the government is still open to the idea of quantitative easing(printing more money). This can only lead to higher inflation being stored up. The people of this country are going to be subjected to high levels of inflation well into the future because of this.

    Lets live within our means, and manage this countrys' resources properly for the benefit of all our citizens and not the priviledged few. There was a time when we added value in our work. Too many people today are adding only cost.

    Report on 10 September 2010  |  Love thisLove  0 loves
  • Ed Bowsher
    Love rating 79
    Ed Bowsher said

    Thanks for all your comments. Very interesting. I can't reply to everything, but I'll do my best to cover a fair bit of ground.

    OR to cut back on expenditure and live within our means. In the Great Depression governments did the latter and eventually climbed back to economic success. 

    That's a controversial statement to say the least! Many would argue that most countries only fully recovered from the depression thanks to WW2 when deficit spending was acceptable to most people and very high.

    Here are some facts about the 30s..... In the three years 37, 38 and 39 more than 500,000 houses annually were built in Britain. In 1939 British motor manufacturers supp;lied 90% of the market and sold 350,000 vehicles.

    Yes, the UK did see an economic recovery in the second half of the 30s - especially in the South. Less so elsewhere. I can give two reasons for this although I accept other factors may also have played a part:

    - we came off the gold standard earlier than many countries in 1931

    - the economy got a bit of stimulus from '36 onwards when the Baldwin government embarked on a modest build-up of military defences.

    "Clearly if the US borrows too much, foreign creditor nations will demand higher Treasury bond yields which could create a vicious cycle of increasing indebtedness for the US."

    That's the risk that the 'bond vigilantes' worry about.

    But if the US government doesn't borrow enough, the economy could go back into recession and the country could have ten years of slow growth. As a result, tax revenues wouldn't rise quickly, and the deficit would get worse. If US budgetary policy is too tight, some creditors might worry that the US would be less able to pay back debt in future, and that could raise Treasury bank yields. We've seen this happen already this year in Ireland and Spain. It's a mistake to think that austerity guarantees low bond yields. It doesn't.

    The problem with the stimulus approach is that it's a one-way bet on things returning to "normal" when it's clear that the global economy is in transition.

    That's an important point. The rise of China/India et al is creating huge imbalances and challenges, and it means that's it's harder to make the right call on what to do now. I accept that. I also accept that in the long-term the UK may have to accept a lower standard of living as a result of the rise of China. (Although conventional economic theory wouldn't support that view at all.)

    If we're looking beyond the deficit at 'big picture' structural issues, then I think the most important factor is our ageing population. That's a huge problem which could hit our economic growth big time. And also has worrying implications for the deficit..

    But I still think that we need stimulus now which will give us stronger growth. That growth will put us in a better position to deal with the challenges of demographics and China.

    Don't get me wrong, I'm not saying we should run a big stimulus forever. It's just that when demand is low, interest rates are super-low, and the private sector is paying down debt, you need government to keep things moving for a while.

    Otherwise we face a potential disaster. Once we've got through this tricky period, good growth will have helped to cut the deficit somewhat but we'll also have to look at cuts and tax increases. But it's too early to start that now. It would do more harm than good and, in my view, is the riskier option vis a vis Osborne's austerity package.

    We have had a stimulus, and look what it's achieved--very little

    I disagree with that. The economy grew 1.2% in Q2 in the UK!

    Admittedly, growth hasn't been so strong in the US, but I'm 99% sure that things would have been much worse in the US had it not been for the stimulus. People forget how bad things were in autumn '08 and how close we were to a financial meltdown. You could quite reasonably have expected much worse economic pain in '09 and '10 without the stimulus package. But we avoided that thanks to the good sense of Bernanke, Obama, and yes, the widely loathed Gordon Brown.

    Darling's pre-election budget was only a holding exercise, and even he had promised to cut "deeper than Thatcher".  

    Yes, he did promise to do that. I think his plans were too aggressive. Darling was sucked into the City/Bank of England consensus. Just like Blair, Cameron and Osborne. That consensus was and is wrong.

    If my teenage son was maxed out on his credit card and was struggling to pay the monthly payment, I wouldn't encourage him to "solve" it by getting another credit card! 

    You've come to the heart of the debate. When it comes to your son, I agree with you. I wouldn't advise him to get a card either. But when it comes to governments, things are different. 

    In certain situations, government spending can create more value in the economy thanks to the 'multiplier.' In other words, government spending of, say, £1 billion, leads to increased consumption spending and more investment. As a results GDP is boosted by significantly more than £1 billion. As GDP has been boosted, the government's tax take is boosted and the deficit doesn't mushroom.

    Fiscal stimuli can be inflationary, but that's not our big problem now. In fact, in Europe and the US, deflation is still a potential threat. Stimuli can also sometimes 'crowd out' the private sector by raising borrowing costs for the private sector. But right now, borrowing costs are still very low for large businesses and much of the private sector doesn't want to borrow. It just wants to pay down debt. Hence the need for a stimulus.

    Sorry, I've got to go home now, but thanks for all your comments.

    Ed

    Report on 10 September 2010  |  Love thisLove  0 loves
  • oldhenry
    Love rating 267
    oldhenry said

    My view is that people have got to get used to less public expenditure. It has to be paid for, it does not drop out of the sky. Who pay? Well, those at work and with taxable incomes and assets. The population of the country is too high for the decent jobs that are available, this must result in a lower standard of living, or a bigger gap between those on a higher standard and those on a lower standard. It all depends on what you are prepared to pay for the levelling of standards. I do not want a drop in mine, but I'll get it as my savings income had fallen dramatically as the Governement's agents- BOE- are forcing savers to lose capital through ignoring inflation and keeping interest rates low. That is a stimulau in any event- and one that should stop as it is folling borrowers into thinking money is cheap.

    Report on 11 September 2010  |  Love thisLove  0 loves
  • shikisha
    Love rating 3
    shikisha said

    Just for general information - I'm a he!

    Report on 11 September 2010  |  Love thisLove  0 loves
  • Savvy chic
    Love rating 20
    Savvy chic said

    I dunno how anyone knows what George Osbourne's cuts are, since the Strategic Spending Review isn't publlished until October.

    However, under Labour, thousands of Public Sector employees were taken on at high salaries and with fantastic pension schemes - to do the same work that had been done without having them on board! (has anyone noticed that they were getting more from their Council during Labour's reign?)

    Quangos were taking millions from the taxpayers and they are now gone. Who can say that's a bad idea?

    Report on 11 September 2010  |  Love thisLove  0 loves
  • daffyduck
    Love rating 5
    daffyduck said

    Stimulus packages are assential and need to gradually reduce our dependance on more indirect stimulation like low interest rates and bank bail outs.

    Our tax payers money being used to support the banks should be on an outstanding interest rate several points higher than the gilts rate - somehow I doubt it!

    The banks have shamelessly used the finance to dig their heels in with lennding and produce a false market of loans where the average commercial loan is 4 to 5 points higher than the MLR.

    When returns on post office accounts were seen as too competitive the government stopped them!

    The Banks are having their cake and eating it and blackmailing the rest of us with threats of financial armageddon if we dont allow them to re-stock their reserves with our money.

    Time to set the banks free and introduce direct stimulus to create productive jobs and invest for tomorrow. Money best spent as follows:-

    Products and services to replace imported products and services

    Infrastructure work to public transport initiatives to bring our systems up to the much higher european standard.

    Build social housing adjacent to where work will be created not just where people wish to live.

    Report on 13 September 2010  |  Love thisLove  0 loves
  • daffyduck
    Love rating 5
    daffyduck said

    In the case of public sector cuts the problem can emerge that organisations end up making the most basic approach to the this process ie last in first out without properly reviewing the nature of their work. Once the redundancy payment has been made they then find out the people they let go were more fundamental to their operation and they have to re-hire of get contract staff - resulting in no saving.

    Public servants are on the whole pretty poor at rationalising the structure of their organisations and quite often the ones deciding on the cuts to be made should be the first to go.

    What i'm trying to get across is that if you try to achieve too much too quickly it end up with the money coming out of a different government pot. ie pensions. and no real savings being achieved.

    Report on 13 September 2010  |  Love thisLove  0 loves
  • Ed Bowsher
    Love rating 79
    Ed Bowsher said

    Shikisha,

    Sorry for getting your gender wrong! I don't know why I assumed you were a woman.

    Savvychic said:

    I dunno how anyone knows what George Osbourne's cuts are, since the Strategic Spending Review isn't publlished until October.

    We don't know the details of where the axe is going to fall. But we know the axe is going to chop aggressively. Osborne has made that very plain. For example, he plans to reduce the deficit to zero by 2015.

    has anyone noticed they were getting more from their Council during Labour's reign?

    You're right, I haven't noticed any improvement in services from my council. But I have noticed improvements in the NHS. Still, I accept that some of the money Labour spent was wasted.

    Ed

    Report on 13 September 2010  |  Love thisLove  0 loves
  • larryf
    Love rating 1
    larryf said

    As always the " man in the street" will bear the brunt of any cuts the government puts in place. The fat cats will, as always, line their pockets somehow. Reading the Sundays yesterday it was disgusting to see the pension pots that so many of these people are walking away with . I think that those high fliers in the banks that were rescued by our money should be held to blame and made to feel some pain in the form of pension pot reductions and salary decreases. At least until such time as they climb out of the self dug holes and pay back the mind blowing sums of money put up to save their corporate skins!

    Report on 13 September 2010  |  Love thisLove  0 loves

Post a comment

Sign in or register to post a reply.

Related content

Our top deals

Credit card
company 		Balance transfers rate and period Representative
APR 		Apply
now

Barclaycard 27Mth Platinum Visa

0% for 27 months (3.5% fee) Representative 18.9% APR (variable) Apply
Representative example: assumed borrowing of £1,200, representative 18.9% APR (variable). Purchase rate 18.9% PA (variable). BT fee is reduced from 3.9% to 3.5% (T&Cs apply).

NatWest Platinum MasterCard

0% for 26 months (2.65% fee) Representative 18.9% APR (variable) Apply
Representative example: assumed borrowing of £1,200, representative 18.9% APR (variable). Purchase rate 18.95% PA (variable).

Royal Bank of Scotland Platinum MasterCard

0% for 26 months (2.65% fee) Representative 18.9% APR (variable) Apply
Representative example: assumed borrowing of £1,200, representative 18.9% APR (variable). Purchase rate 18.95% PA (variable).
W3C  Thank you for using CGWEBLIV1