GreenAB

Koo always is a refreshing read.
but i still don´t get why so many there give him so much credit.

of course it would be great if we could have macroeconomic policies that guarantee uninterrupted growth.

but that is just a pipe dream imo.
we´re living in a world where laws of nature apply, which means that if you´re overpowering you have to rest at some point in order to regain strength and go again.

1.)when discussing stimulus i have read none economist who looks at the past and current. let´s say the economy grew above long term trend for 5years.
bubbles developed in asset prices, inventories surged and capacity increased.
how and WHY do you stimulate when the economy is largely oversupplied?
where do you direct capital in a way that it works efficiently and keeps the economy moving forward?
the more saturated an economy the less bang you get four each buck borrowed and spent.
in the regard China will be interesting to watch in the years to come.

2.)bubbles will be even bigger.
take the biggest parts of the economy that are most likely to be stimulated in a downturn, like housing, auto manufacturing or financials.
if you know that the government stands ready to push demand indefinitely once the economy weakens – why should take responsible decisions as a business leader?
of course you´d take on more risk consequently taking inflation higher.

3.)the third issue is with Keynesian theory itself:

you stimulate when the economy is weak. you save when the economy is booming. right?
for the overwhelming part of the last 30 years the economy was growing.
so HOW come that the deficit is in the record trillions today?
the reason is that you will never find a politician who will put the savings part into action. if there ever is a surplus, it will be spent! (or you can forget reelection)

4.)outside there´s a MARKET that has EXPECTATIONS.

a dramatic change in macroeconomic policiy as Koo advocates would of course alter these expectations and with it the availabilty and price of (sovereign) credit.

let´s say politicians all over the world suddenly convert to “stimulate to infinity”.

to me as a potential creditor, a buyer of sovereign debt that would translate into:

-debt won´t be a last resort measure if balancing fails. it becomes a systemic tool which every local/sovereign government will make “pain free” use of
-therefore the amount of debt will increase substantially
-paying back debt is NOT the first priority of the government any longer
-the return of my capital is highly dependent on the return of sufficient economic growth AND the willingness of new creditors to finance deficits

one could argue that the last two points are already existent in todays market.
everybody knows that todays deficits cannot ever be paid back.
but at least on paper there is a hard commitment to rebalance the budget by spending cuts/raising taxes to pay back the debt.
imo there´s still a substantial part of the market that believes that the political leaders will at least try to honor that commitment.
if you kill that commitment you both lose that part of the market and as mentioned above the debt supply will explode.

the effect cannot be quantified right now.
but i expect that volume would drop and interest rates would skyrocket killing the great plan and the existing budgets over night.

that would be a fun experiment:
let´s say you have a listed company that is losing money every quarter.
they have no clear time table to profitability and they don´t intend on lowering costs. instead they release a statement that from now on they´ll raise equity only, thereby diluting current and future stockholders until they finally reach profitability. guess what the market would do to their stock price and what discounts will be required to attract new investor with every follow on offering…

but let´s say the bond market doesn´t break for now.
we follow Koo and stimulate for another 5years until the economy is back at 2007 levels.
then what? we´re again at the savings part of the theory. nobody will do it.

the economy might see another up cycle of 5years self sustained growth
over that time period the deficit at best will grow slowly.
imo it will grow faster than during historic growth cycles because politicians will make heavier use of debt when justified by Koos theory.

sooner or later the natural imbalances of the cycle will reappear and the economy will be faced with another recession.

then again – stimulate,stimulate,stimulate.
send the deficit higher again.

sooner or later we´ll get to the point that either interest rates or the sheer size of the deficit will get the bond market to break.
we´re on track for this outcome right now as well.
but with Koos policy we might reach that point much faster.
and if so the consequences would be even harder since his policy doens´t allow for periodically built bubbles to correct.

to sum it up:

-it´s unclear to what point saturated economies can be stimulated
-higher risk taking, higher inflation likely
-the mirror of stimulating – saving will never happen
-sovereign debt supply would explode
-market expectations and with it interest rates and liquidity would change suddenly
-the inevitable self correcting mechanism of the economy would only be delayed, endgame unclear, potentially devastating