As George Soros noted in his recent NY Review of Books piece, before the recent G20 meeting in Toronto, Germany’s deflationist stance was the minority position. By the end of the meeting the American reflationary stance was the minority position. Abruptly, and against the apparent ‘we are all Keynesians now (again)’ love-fest of 2008-2009, the G20 signed up to halve their budget deficits by 2013. Government spending, it seems, has to stop.
Now the G20 does have a point. There is too much debt in the system, from consumers, to corporations, banks, and sovereigns. But as I blogged in a recent piece for Foreign Affairs, the G20’s endorsement of “growth friendly fiscal consolidation” relies on the same fallacy of composition that brought on the banking crisis. Back in the glow of the ‘Great Moderation’ regulators assumed that by making individual banks safe you make the system as a whole safe. Unfortunately, as the world discovered through learning terms like ‘CDS daisy-chains’ and ‘serial correlation,’ that turned out to be a really bad assumption. Now, in a re-run worthy of Nick-at-Night, we are about to simultaneously retrench in the middle of a recession in order to restore growth.
Those who warn of the dangers of debt argue that ‘normal service has been resumed.’ For all the Keynesian ferment the simple fact remains that markets react to bad policy, and bloating government debt to prevent a normal market correction was bad policy.
While appealing in a ‘bulimia bad/dieting good’ moralizing sense, such a view ignores that, according to the IMF, of the 39.1 percent (average) increase in government debt across the OECD only 12 percent of that increase was discretionary. The rest was a direct result of bailing out the banks. So it’s more than a little ironic to note that what the G20 are responding to – Eurobond market pressures – are coming from the same banks that used those bailout funds to buy super-cheap underwater assets while short-selling the government debt generated in the process of saving their assets.