America needs stimulus not virtue

George Soros | Financial Times | October 04, 2010

The Obama administration’s insistence on fiscal rectitude is dictated not by financial necessity but by
political considerations. The US is not in the position of Europe's heavily indebted countries, which must
pay hefty premiums over the price at which Germany can borrow. Interest rates on US government bonds
have been falling and are near record lows, which means that financial markets anticipate deflation, not
inflation.
President Barack Obama is under political pressure. Americans are deeply troubled by the accumulation of
public debt. The Republican opposition has been extremely successful in blaming the crash of 2008 and
the subsequent recession and high unemployment on government ineptitude.
But the crash of 2008 was primarily a failure of the private sector. US (and other) regulators should be
faulted for failing to regulate. Without a bail-out, the financial system would have remained paralysed,
making the subsequent recession much deeper and longer. Similarly, the US stimulus package was a
necessary measure. The fact that most of it was spent to sustain consumption rather than on correcting
the underlying imbalances was unavoidable due to time pressure.
Where the Obama administration went wrong was in how it bailed out the banking system: it helped the
banks earn their way out of a hole by purchasing some of their bad assets and supplying them with cheap
money. This, too, was guided by political considerations: it would have been more efficient to inject new
equity into the banks but the president feared accusations of nationalisation and socialism.
That decision backfired, with serious political repercussions. The public, facing a jump in credit card
charges from 8 per cent to nearly 30 per cent, saw the banks earning bumper profits and paying large
bonuses. The Tea Party movement has exploited this resentment and Mr. Obama is now on the defensive.
The Republicans campaign against any further stimulus and the administration now pays lip service to
fiscal rectitude, even if it recognises that deficit reduction may be premature.
I believe there is a strong case for further stimulus. Admittedly, consumption cannot be sustained
indefinitely by running up the national debt. The imbalance between consumption and investment must be
corrected. But to cut government spending at a time of large-scale unemployment would be to ignore the
lessons of history.
The obvious solution is to distinguish between investments and current consumption, and increase the
former while reducing the latter. But that seems politically untenable. Most Americans are convinced that
government is incapable of managing investments aimed at improving the country’s physical and human
capital.
Again, this belief is not without justification: a quarter-century of calling the government bad has resulted
in bad government. But the argument that stimulus spending is inevitably wasted is patently false: the
New Deal produced the Tennessee Valley Authority, the Triborough Bridge in New York and many other
public utilities still in use today.
Moreover, the simple truth is that the private sector does not employ available resources. Mr. Obama has
in fact been very friendly to business, and corporations are operating profitably. But instead of investing,
they are building up liquidity. Perhaps a Republican victory will boost their confidence but, in the
meantime, investment and employment require fiscal stimulus (monetary stimulus, by contrast, would be
more likely to stimulate corporations to devour each other than to hire workers).
How much government debt is too much is an open question because tolerance for public debt is highly
dependent on prevailing perception. The risk premium attached to the interest rate is the critical variable:
once it starts rising, the existing rate of deficit financing becomes unsustainable. But the tipping point is
reflexive and therefore indeterminate.
Consider Japan, with a debt-to-gross-domestic-product ratio approaching 200 per cent, one of the highest
in the world. Yet 10-year bonds yield little more than 1 per cent. The reason is that Japan’s private sector
has little appetite for investing abroad and prefers 10-year government bonds at 1 per cent to cash at 0
per cent. As long as US banks can borrow at near zero and buy government bonds without having to
commit equity, and the dollar does not depreciate against the renminbi, interest rates on US government
bonds may well be heading in the same direction.
That does not mean that the US should maintain the discount rate close to zero and run up debt
indefinitely. The right policy is to reduce imbalances as quickly as possible while minimising the increase
in borrowing. This can be done in several ways, but the Obama administration’s stated goal of halving the
budget deficit by 2013 while the economy is operating far below capacity is not one of them. Investing in
infrastructure and education makes more sense. So does engineering a moderate rate of inflation by
depreciating the dollar against the renminbi.
What stands in the way is not economics but misconceptions about budget deficits that are exploited for
partisan and ideological purposes.
Source: Financial Times