Crying Wolf & The F-Word

Posted by John Ross Crooks - Black Swan Capital

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Key News

  • Exports to fast-growing Asia including China, which accounts for more than half of Japan’s total shipments, rose 34.4 percent from a year earlier, slowing for the fourth consecutive month after they jumped a record 68.3 percent in January (Reuters)
  • South Africa’s rand weakened over 1.2 percent against the dollar on Thursday, some of the losses coming after official data showed the current account deficit widened in the first quarter of this year. (Reuters)
  • The World Bank on Wednesday urged the Group of 20 major economies to agree on steps to safeguard the global recovery warning that setbacks will further strain resources in poorer countries. (Reuters)


“Whether it’s the late twenties or two thousand and five
Booming bad investments, seems like they’d thrive
You must save to invest, don’t use the printing press
Or a bust will surely follow, an economy depressed

“Your so-called “stimulus” will make things even worse
It’s just more of the same, more incentives perversed
And that credit crunch ain’t a liquidity trap
Just a broke banking system, I’m done, that’s a wrap.”

F.A. Hayek, Fear the Boom and Bust

FX Trading – Crying Wolf: The F-Word is Like a Prescription Drug.

Martin Wolf of the Financial Times recently referenced a paper that made the case that fiscal contraction will actually stoke consumer confidence and induce consumer spending that is necessary towards achieving a healthy recovery. Cut spending and taxes, so the argument goes.

That’s a very interesting idea. Wolf went on to propose some reasons, however, that that idea won’t work in this environment. Perhaps the main reason: consumers are still in deleveraging mode, unwilling to spend much. Duly noted.

And that reason alone might be enough to justify sustained fiscal spending … at least for the fiscal spenders among us. In which case we’re still right smack where Jack mentioned yesterday: “Keynesian money pumping isn’t working!  (Unfortunately given the pathetic state of politics here and everywhere, we will never get a real test of just “letting the market cleanse itself” which requires government getting out of the way.)”

No – spending is the way to go; tax cuts are not. Get that in your head. We’ll never (completely) know just how unnecessary and unproductive fiscal spending may be; and we’ll never (completely) know just how much more effective substantial tax cuts may be at fortifying and stimulating US consumers and investors.

Government spending is like a prescription drug – it aims to solve short-term illnesses while the rest of the body recovers. But just like so many drugs out there today, they slowly do long-term harm to your body in some way, shape or form even if they appear to cure you in the here and now.

The long-term harm is starting to show up on the charts. Paging doctor Hayek.

The Federal Reserve yesterday made no changes to interest rates but did sound off a sobering note regarding the US economic recovery. Among all the analysis was a brief mention of inflation, which they noted as trending lower. This is likely one of their larger concerns as it seems the Fed is scared of any face-off with deflation.

The Fed’s easy monetary policy goes hand-in-hand with the inclination towards fiscal spending. And it’s a combination that may make their worst nightmare come true: Japan.

They’re afraid of falling into Japanese-style, decade-long deflation. But what they fail to recognize is that they’re grabbing on to a similar strategy that didn’t help Japan skirt deflation. 

The natural prescription, assuming a free-market stance, is to find an appropriate level for interest rates and let the public and private sectors deleverage until the malinvestments wither away and savings build. At which point the incentives to invest and spend will be less perverse, if not sensible.

Going back to Martin Wolf again, my emphasis:

“Premature fiscal tightening is, warns experience, as big a danger as delayed tightening would be. There are no certainties here. The world economy – or at least that of the advanced countries – remains disturbingly fragile. Only those who believe the economy is a morality play, in which those they deem wicked should suffer punishment, would enjoy that painful result.”

Mr. Wolf, you’ve got a career of bigger and better things ahead of you. Typically spin like that is reserved for corrupt bureaucracies. 

The economy is a morality play; everything is a morality play. But your qualifier is backwards, twisted. Those moral types don’t deem anyone wicked, and they do not wish punishment on anyone who is not deserving of punishment. Yes, it would be a painful result that surely is not enjoyable, despite being the best option. Spreading the pain around, however, makes everyone suffer punishment, even those who do not deserve it. 

Austerity is the word in Europe; and it is likely going to create some additional struggles before problems become solved. Based on the social mood over there, much of the area’s citizens appear frightened and unwilling to accept austerity. 

The mood is a bit different in the US, where citizens seem fully ready to accept austerity, to have the government stop spending, to have their hard-earned money stay their hard- earned money. It may take a couple years of high unemployment, but maintaining the American spirit and economic prosperity over the long-haul is worth it.

John Ross Crooks III
Black Swan Capital