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Why GDP growth doesn't necessarily mean a healthy economy


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Everything regresses to the mean. Everything tends to go back to normal.

Corrections are normal. They help things get back in balance.

Now, here’s the interesting thing. While Japan’s government tried to prevent it, the Japanese private sector de-leveraged. Over a long period of adjustment – 20 years – the household, business and financial debt went down by about 40%, in GDP terms.

And now, in the US, even though the government tries to hide prices and delay the correction, the private economy is still de-leveraging. The latest figures suggest that households took a little pause in the first quarter of this year. Savings actually went down as consumption went up. But if we continue to follow the Japanese example the de-leveraging should resume soon.

We know from the Japanese history too – if we had any doubt about it – that price hiding doesn’t work. First, they tried fiscal stimulus. That didn’t do anything. The banks took the monetary stimulus and held onto it, just as US banks are doing now.

Then, they tried fiscal stimulus. Now, this deserves a little discussion. Because Richard Koo among others argues that the fiscal stimulus did work in Japan. He points out that Japanese GDP did not drop significantly – thanks to massive doses of fiscal stimulus. And now, Paul Krugman and others are saying that fiscal stimulus has worked in the US too…because our GDP only went down less than 3% in what they call the Great Recession.

Here is where we see the claptrap theories at work. Fab Finance turned the economic profession from historians and philosophers into mathematicians and engineers. Dozens of these fellows won Nobel Prizes for elaborate mathematical proof of what were essentially bogus or inconsequential ideas.

And now they turn to GDP as proof that fiscal stimulus works, without bothering to think about what is really going on. GDP measures economic activity. Like everything else in modern finance, it is sensitive to quantity and completely ignorant about quality. To borrow from Oscar Wilde, it knows the price of everything but the value of nothing.

Yet, here again, as the Soviet Union showed us, you can summon up all the GDP you want. Just divide the country at the Mississippi. Get half the population to dig a big hole in Tennessee…and get the other half of the population to fill it up. Imagine the trucks…the fuel…the machinery…the labor…the housing you’d need… GDP would go up. You’d have full employment. Modern economists would be content with themselves. They’d sit by the phone, waiting for the Nobel committee to call.

But what would you really have?

You’d have Japan! That’s what the Japanese did. Well, not quite like that… They put people to work building roads and bridges…pouring concrete on a massive scale. Until then, Japan had the healthiest government finances in the world. Now, it has more government debt/GDP than any other nation – approaching 200%..

And think about what really happened. Japan’s population is getting older. These are people who lent the government money so that it would be safe. They wanted to be sure they’d have the money they needed when they retired.

But where is that money? It has literally been poured into a hole in the ground. The savings of an entire generation have been turned into bridge abutments and canals – most of them unnecessary and many of them unwanted.

That is what is happening in the US too. Except we don’t have enough savings to finance our own holes in the ground. We’re more like Greece.

And like Greece, we will pay a high price when the final correction comes.


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