The scale of the deficit is truly extraordinary. 12.5pc of GDP is not something that anybody would have anticipated even a year or two ago and this reflects the scale of the global downturn. But it also reflects the fact that we came into this crisis with fiscal policy itself on a path that wasn't itself sustainable and a correction was needed.
The speed of which the fiscal stimulus should be withdrawn has to depend on the state of the eocnomy. There is no point in presenting a profile for the reduction of deficits that is independent of the state of the economy.
There will certainly need to be a plan for the lifetime of the next parliament, contingent on the state of the economy, to show how those deficits will be brought down if the economy recovers to reach levels of deficits below those which were shown in the budget figures.
In other words the deficit is very worryingly large, but it has to be endured, and action needs to be taken in the medium term to shrink the deficit. So far, so conventional. However, it is in his later discussion that the underlying contradiction becomes apparent:
To ensure a sustainable recovery and prevent a repetition of the crisis we must reform the international monetary system. The United Kingdom and other deficit countries will now be aiming at more sustainable levels of domestic demand.If we look at the earlier comment and this comment, it is apparent that there is a contradiction in the argument. On the one hand the suggestion is that the fiscal stimulus is necessary, and on the other that there needs to be a change to 'more sustainable levels of domestic demand'. If we actually view the nature of the objectives of the stimuli, and the underlying reason for the government deficit spending, it is exactly the opposite of sustainable domestic demand.
From this document of the Treasury Select Committee in February, we can find the following quote from Mervyn King (key section highlighted):
I think this goes back to what I call the paradox of policy. I think it does not make sense to engage on a national campaign to raise savings rates in the very short run; we will need to do so once we get out of the crisis. In the short run we have to engage in measures to ensure that spending returns to more normal levels in order to prevent significant falls in output and rises in unemployment. Once we have got through that immediate problem, then the challenge will, indeed, be to raise the national savings rate, both public and private. [answer to question 5]The question here is the question of what normal might be. Is it debt fuelled spending, which is unsustainable, or is it the reduced spending indicative of sustainability? It does not matter whether the deficit is originating in consumer spending or government spending, the current domestic demand is not sustainable. In both cases, the country is in aggregate consuming more than it produces, and this is not sustainable. Why delay the shift to sustainable demand? Why not make the shift now?
What we are seeing here is a recognition of the underlying problem, but a refusal to act to rectify the problem. It can not be put more simply than this. If we are consuming too much now, we surely need to stop. Now.
To use a metaphor, Mervyn King has diagnosed the illness, but does not have the courage to suggest taking the unpleasant medicine now. Instead, he is proposing letting the illness run on even longer, even though it will do even more damage to the body in the meantime. I just hope that he goes further, and actually has the courage to call a halt. He may actually be in a position to have the influence to actually achieve this.....
More on the Bond Smuggling
I have been keeping an eye on the bond smuggling story (see here and here), and have noted that absolutely nothing is being added to the story. There is still no official word from the US, other than stories repeating the comment that, from pictures seen on the Internet (???), an official suggested that they were fake. As yet, no official report on the authenticity of the bonds. Nothing has come out of Italy.
This story is surprising in the respect of the complete lack of any definitive information from official sources. Bearing in mind the level of speculation about the story, it would be reasonable to expect that some kind of official statement would be made.
I have also been thinking about the breaking of the story. I do not know how the Italian police operate, but usually, whenever there is a major 'bust' the police arrange a press conference. I can think of no larger bust than foiling a $134.5 billion counterfeiting plot. What I would normally expect from such a story is a crowded press room, the chief of police smiling at the press and introducing those who caught the criminals, followed by a sample bond (in a plastic bag) held aloft for the photographers. In short, the bust should have been presented as a triumph. The police are not normally so shy of promoting their success....instead, nothing....
In short, I keep coming back to this story as it is all very odd. I find the ongoing silence to be a continuation of the oddness. In particular, why nothing from the Italian authorities? The only explanation, and it is quite a reasonable explanation in principle, is that there is an ongoing investigation. However, how does that fit with the story of the smugglers being released?
I will continue to update you if there are any developments. However, if there are no developments, then I think that we might conclude that there really is more to this story than meets the eye. After all, why would there be such silence on the largest counterfeiting operation ever?
You may have noted that I have not been very responsive to comments of late. It is, unfortunately, one of those times when real life is rather busy, and I am therefore extremely short on time. I have also been trying to devote time to the fixed fiat currency idea, which is very long and complex, and have also been preparing a post on QE (hopefully to follow shortly). Apologies for this, and I hope that I will be able to devote more time after a week or so.