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Bank Bailouts and Voodoo Economics
Does the phrase “voodoo economics” sound familiar?
To some of you it might. Back in 1980, when Ronald Reagan was running for the Republican presidential nomination, his rival George H.W. Bush made sport of Reagan’s belief in the free market economy by calling it “voodoo economics.”
Reagan, of course, went on to win the Republican nomination and defeat Jimmy Carter by a landslide. The following eight years of Reagan’s Presidency was based quite a bit on his “voodoo economics.”
By lowering taxes and reducing the levels of regulation by a third, businesses in America thrived and millions of jobs were created. The American economy recovered from its recession and had fantastic growth throughout most of Reagan’s two terms in office.
Now don’t get me wrong, voodoo economics is a catchy term; it was just misused by Mr. Bush in 1980.
But 32 years later, voodoo economics has finally found the home it deserves…
That voodoo that we do
Nobel laureate economist Joseph Stiglitz applied the term voodoo economics precisely where it belongs…
In the same sentence with the bank bailout plans for Spain. He said last Friday that…
"It's voodoo economics; it is not going to work and it's not working."
I couldn’t agree more with former economic advisor to the Clinton Administration…
Or disagree, too.
You see, I agree with Mr. Stiglitz that bank bailout won’t solve the problem…
The problem is, he thinks that a bailout for Spain’s banks doesn’t go far enough.
The high profile economist believes that the Eurozone needs to become more unified, with more debt in the form of Eurobonds, tighter political and fiscal controls for all of the Eurozone…
A “European system” he said, is what is needed.
To translate that into plain English, he is in favor much more spending, greater government control of the Eurozone economies, and much more debt as a way to fuel growth.
That is, he agrees with what we are doing here in the US.
Can Austerity lead to growth?
Mr. Stiglitz is also a critic of the austerity plans that are in place in Greece, Ireland, Italy, and Portugal…
Because the austerity plans promote cutting costs and debt in order to bring the national budgets under control…
In other words, the austerity plans, as tough and mean as they may be, are meant to restore those debtor nations to a state where they are not depending on greater and greater debt in order to survive.
Do austerity measures make a recession worse? In the short term, the answer is ‘yes.’
But in the long-term, austerity allows a nation to balance its budget, pay down debt, and live within its means, so that economic growth is organic, from the private sector.
Iceland, which I have talked about before in The Gorrie Details and was the first country to be hit by the financial crisis, did not bail out its banks…
But it did guarantee depositors their money in Icelandic banks…and let the banks themselves, who were over-leveraged, fail.
And fail they did.
Iceland also cut public spending, pensions, and public jobs…
In other words, they adopted austerity…and so far, it is working.
Today, they are on their way to economic recovery.
In fact, their economy is expected to grow 2.5% this year and the next as debt falls below 100% of GDP.
Isn’t that something? I guess austerity can be a real growth plan after all…
And the nice thing about it is that growth that does not depend on borrowed money spent on government-funded projects...
And does not confuse public deficit spending with economic activity.
Which is what the US wants Europe to do.
Is that kind of debt-fueled growth, really growth at all? Or it is a false economy?
Isn’t that the kind of “growth” that got the Eurozone PIIGS nations where they are today in the first place?
Does it make sense to add more voodoo when the first few doses have left the Eurozone sick and weak?
And as for bank bailouts actually resulting in growth, is that really the case?
We have been playing with voodoo since at least 2008, and “growth” in the US economy has mostly been a mirage…
Our banks have been bailed out with over a trillion dollars from the Fed, interest rates have been kept at historical lows for years, and will be held low until sometime in 2014…
And yet unemployment is still very high…
And credit is still very tight.
Thus, the housing market—the key to any economic recovery—has not yet recovered…
And the US economy is slowing down after very minimal growth that is most likely a result of cooking the GDP numbers in a similar way that the employment figures have been skewed…
The numbers are made to look better than they are for political purposes, but do not reflect reality.
As I noted in a recent Gorrie Details article, Federal Reserve Chairman Ben Bernanke wrote in his research paper back in 1988 that bank bailouts do not make the economy grow…
Because when banks receive funds from the Fed or the government, they have no incentive to lend money.
This is true for many reasons…
When interest rates are held so low, as they are now, there is very little margin for profit in lending to businesses…
Not only that, but banks that were bailed out by the Fed are paid interest by the Fed for holding onto their reserves. It’s called interest on excess reserves.
Banks are actually paid not to lend.
Then, of course, when the banks do lend, it is not to businesses—the economy is too risky for that…
Instead, the banks have been lending their bailout money back to the government by buying T-bills.
This is great for them because it gives them a nice margin on their money without the risk of a business loan.
It’s a very cozy deal for the banks, the Fed, and the government, who has a captive buyer of T-bills in those banks.
It’s great for large corporations and the stock market, too; but it hasn’t worked for the rest economy, has it?
And yet, this is the “growth policy” that the US is urging Europe to take on board…
Voodoo economics, indeed.
And those are…The Gorrie Details.
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