Greatest Moral Hazard, Says Paul McCulley, Is Austerity Here And Now (Mauldin)

That could very well be the case. But that diversion of attention is unfortunate because it clouds people’s vision of the larger picture, which is pretty straightforward. It’s really textbook sort of stuff. My friend, [Nobel Laureate, Princeton Economics professor and New York Times columnist] Paul Krugman, has been writing a great deal about it recently. If the private sector is delevering and derisking and you’re caught in the paradox of thrift, the public sector is supposed to go in the exact opposite direction. The exact opposite direction.

You mean that cutting federal spending in a liquidity trap, like we’re in, is absolutely counterproductive?

Yes, it’s ludicrous and I don’t use that word too often. There’s a large range of opinions about most issues, and rightfully so. But if you are in a liquidity trap and you are advocating frontloaded austerity—

The Tea Party is really talking about killing the economy —

Again, it’s absolutely ludicrous. And if we need an example, we can just look across the pond and see what’s going on in Euroland. Putting somebody who is suffering from anorexia on a diet doesn’t make a lot of sense to me. But essentially that’s what the austerity folks are preaching and that’s what we’ve been grappling with here in the United States.

Of course, the proponents of austerity are worried that this country’s debt load is already too much for future generations to handle.

“We have to go on a diet for our long-term well-being. The only question is how severe of a diet?” — That is the question being asked. As opposed to what we should be discussing, which is, “Gosh, we’re talking about someone who is underweight here! Why do we need to be on a diet? Maybe we should have more food!” Incredibly, to suggest such a thing is to be considered a heretic these days. Paul actually gets more wound up about it than I do. I enjoy reading him now with the luxury of doing it whenever I get around to it during the day. I just smile. Though on any given day, I have to admit to a bit of envy, from the standpoint of thinking Paul’s piece was really good, but that if I were still in the arena, I could have upped his ante. But his is a really good ante, in just calling out the silliness. That’s what worries me the most about the domestic economic scene — and the global economic scene, too — this presumption that seems to be in currency that government is the problem. Therefore, if we can simply reduce the government, the problem will go away. That is not the case at all, when the problem is actually the combination of a liquidity trap and the paradox of thrift. If you take the government out of the picture, you exacerbate the pre-existing conditions. Yet that seems to be where the body politic conceptually has gone.

Are you implying that the Tea Party has been sold a bill of goods?

Yes, they have. I mean, the historical parallel that a lot of us point to would be 1931, when Andrew Mellon said, essentially, liquidate, liquidate, liquidate and assets will be transferred to moral hands, and we’ll live a more moral life.

Until we starve to death.

Right — but we will live a moral life.

Mellon was quite the Austrian—

Absolutely, that was in 1931. Then in 1937, when it looked like the economy might have been having “a decent” economic recovery, we decided to slap it in the face with monetary and fiscal policy tightening.

And it only took World War II to lift us out of that extension of the Depression.

Yes. What I mean is that the war in effect forced the application of the government’s balance sheet to a deficiency of aggregate demand — and it worked. Some might call that Keynesianism, and I would. But you could describe it more simply by saying that the government’s balance sheet — including the central bank’s balance sheet (because the Fed was subordinate to the fiscal authority during WWII) — was used to stimulate aggregate demand. And it absolutely worked, although I don’t think anyone would applaud going to war to accomplish that. However, it is interesting that after World War II the biggest concern in economic policy circles was that we would fall back into a depression because we were taking away all of the government demand, for the war machine. But what we found out was that this didn’t necessarily have to be the case. Partly, the postwar recovery came about because of the infrastructure and the technologies, etc., that had been developed during the war. But another important ingredient after the war was the GI Bill.

The GI Bill and the Marshall Plan basically saved the West.

And they both used the government’s balance sheet, I’ll point out. My dad went to college on the GI Bill. He was one of the youngest WWII veterans — he’s 85 now but he went into the service in ’44.

Same as mine.

So he went to college on the GI Bill, bought his first house on the GI Bill — and he didn’t consider either one of those to be welfare.

No doubt, he thought he earned it.

Yes, and the payoff to society of the Marshall Plan and the GI Bill were absolutely monstrous. The private sector simply can’t internalize the rate of return on that sort of thing. So this presumption that somehow government investment is bad and private sector investment is good—

Hold on, you’re using the term “investment” and that’s not politically correct. You’re supposed to call it, “spending, waste and fraud.”

Okay, so my dad’s education and the house that I grew up in were, what were those words? “Waste and fraud”?

Yes, according to the conservative meme, it was “wanton government spending” allowing your family to live above your means. The argument that a family has to live within a budget and therefore so does the government, is so specious—

Absolutely. The irony of all this is that I now hear my dad ranting and raving about “big government” at 85 years old— and it was big government that paid for his education and put him into his first home. The real notion that people have is that government is bad — unless it’s helping me!