(This guest post previously appeared at the author’s blog)
There is legitimate argument in the United States that a certain level of government spending was justified in 2009. Given the extraordinarily low levels of aggregate demand, high unemployment, high output gap, etc. the government had a certain amount of wriggle room in terms of bolstering the economy via spending without creating harmful levels of inflation.
Of course, as we all know now, much of this spending was poorly targeted and does little to target the actual problems in the United States (primarily the high level of unemployment), but this was nothing compared to what China has done to its economy. Although China was suffering from a dramatic slow-down they had few of the problems that were crippling America. Savings were high, debt levels were low, etc. But they implemented a massive Keynesian response that is now rippling through an economy that is very much overheating.
We are now seeing signs that this government spending has resulted in increased mal-investment, rampant speculation and pockets of inflation. The Chinese are attempting to front-run these issues, but like the U.S. Central Bank over the last 25 years, they are learning how difficult it can be for a Central Banker to thread the needle via monetary operations. This evening, China implemented a “draconian” measure when the State Council stopped lending for third-home purchases. China has benefited greatly from their recent move to more capitalist markets, but they are quickly learning the failings of the Keynesian belief that government can solve all problems via spending. The Chinese market is down a whopping 4.8% overnight and in my opinion, remains the greatest threat to the global recovery. GMO appears to agree.
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