Fiscal And Monetary Tightening Will Be Painful, But It's The Only Way To Avoid A Global Hard Landing

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The fellows who won the Nobel Prize for Economics, Alvin Roth and Lloyd Shapley, got the prize for a Micro Economic/mathematical analysis. They came up with models/algorithms that make the process of connecting needs to resources better/faster. This appears to be promising stuff that will have broad applications in years to come. The award sure sounds important:“For the theory of stable allocations and the practice of market design.”   

The 2012 Nobel for Economics is not unlike the prize that was awarded to Myron Scholes and Bob Merton for their pioneering work back in 1997. The description from the deep thinkers in Stockholm for that award:

“For a new method to determine the value of derivatives”

The Black-Scholes model is the basis upon which 100s of trillions of derivative contracts have been created. We know what an important contribution to growth and prosperity derivatives have proven to be, right?

Forget Micro economists. What the world needs is a few Macro guys who can provide some direction for the incredible number of economic problems that are at hand (and the bigger ones that are looming).  Damn near every country on earth is staring critical issues in the face.

Where are the economists that have creative and viable solutions?  There aren’t any. The reason is, there are no creative and viable solutions. There are only two schools of thought:

Austerity – This sounds good, but it has been a miserable failure so far. Look at Spain, Ireland and Greece. Think about what the Fiscal Cliff will do for America. If the US goes down the road of austerity on 1/1/2013, the immediate consequence will be a substantial recession. Unemployment would rise, tax receipts would go down, budget deficits would balloon. Nothing would be accomplished by American austerity, other than more pain and more red ink.

Keynesian Economics – This takes many forms, but ends with the same thing; Governments borrow money in an effort to maintain demand. Keynesian pump priming works for your garden variety economic slowdown. But there is nothing about the past four years that is garden variety. Deficit spending may have blunted the global decline for a few years, but at what cost? In the USA, federal debt has risen from $9.2T to $16.2T in the past four years. It may have “felt good” when the borrowed money was being spent, but it will hurt like hell as the interest and principal has to be paid back for the next 20 years.

There are a lot of good economists working at the Central Banks. They have short-term solutions for long-term problems. They have been applying those short-term solutions for four years now. Guys like Bernanke have promised that short-term monetary measures will be continued for at least another two more years. No doubt, oodles of zero cost money can provide a boost to an economy, but at what cost?

If you break your leg, you go to the emergency room, get a cast and begin the process of healing. Monetary policy is not unlike the emergency room. Y0u get patched up, and shortly thereafter you have to start walking on your own. The Fed moved at ambulance speed in 2008/09 to provide much needed emergency treatment. Four years later Bernanke has moved the patient to a hospice. The patient is receiving constant doses of morphine. The palliative care has made the patient comfortable, but death is inevitable and the clock is ticking.

Want proof? Look at Japan. 20 years of ZIRP has translated to 300% Debt/GDP. Japan is an accident waiting to happen.  The USA is (functionally) in year eleven of the Japanese experience.

The fact is, western economies have to adjust to the realities of a rapidly ageing population. China has its own set of ageing issues as the one-child policy is now creating a shortage of young people to support old. These forces are far more powerful than the puny tools of the the Keynesians and the uber-monetary policy wonks.

We need a few economists to step forward to acknowledge the ageing trap. The “deciders” of global monetary and fiscal policy have been constantly sending the same message: 

Give us another year or two, and we’ll have all the problems licked!

There is not a chance in hell that they will succeed. It’s as if they don’t understand the essence of the problem.

A friend sent me some thoughts related to this. Quite dismal, but accurate:

The only way to have a soft landing is to accept a global recession as a consequence of the fiscal and monetary consolidation needed to get the world on a sustainable path.  It’s either that, or blast off and nuke the place from space, it worked in Aliens, maybe that’s what we need here.

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