Interpreting Krugman's Austerity
By Chris Turner
May 2, 2013
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When confronted with issues of the day that affect future performance of investment portfolios, some issues catch my eye more than others. Some articles of late from Professor Paul Krugman appear to be contradictory to his Keynesian beliefs. Rather than try to debate someone undebatable, I thought more instructive would be to show some charts and let readers interpret the results.
While reading David Stockman's new book, The Great Deformation, I thought of some interesting ideas to transform into charts. Professor Krugman goes to great lengths to obfuscate issues, so why not look at debt, specifically US Federal debt several ways.
First in the series, we look at some simple basics. The chart shows our Gross National Product, the tax base (receipts) as a percent of GNP, and the spending (outlays) as a percent of GNP.
Post 1929, readers may clearly discern the very high spending during WWII followed by a relatively stable period of receipts to spending (both averaging around 17% of GNP). Then post 1971 (after Nixon bailed on the gold standard according to David Stockman), readers see that spending ballooned to nearly 23% during Reagan's first years. Spending only dropped below taxes paid briefly during Clinton term, then back off to the races for spending while taxes dropped to the present day 15%. This chart shows that regardless of one's politics, both Republican and Democratic presidents spent considerably more than receipts.
To provide an alternative view, the next chart shows the growth of government spending and receipts on a dollar basis. The chart highlights our current spending of 3.7 Trillion and current tax receipts of just under 2.5 Trillion.
This chart might deceive some readers in that we expect things to increase in costs over the years, but these numbers have been adjusted for inflation. What is remarkable is that we spent less for government during WWII and didn't match that number again until 1973. Again, this chart shows that as receipts grew (which makes sense due to growth in population and Gross National Product), government spent all of the receipts. The chart also shows the same information post 1971 when our currency became fiat once again.
Looking at just government spending and receipts, the next chart divides the spending side by the receipt side and expressed as a percentage.
This chart begins in 1913 (due to the availability of data) to show the impact of spending VS receipts. Using 100% (when spending and receipts are equal) as a baseline, WWI spending was 350% of receipts.
The shaded area removes the spending from the world wars (and depression) and is shown in the following chart.
I placed the presidential terms and recessions to essentially show each administration's spending habits. This chart should be read by Professor Krugman to show that G.W. Bush would be on the top of the Keynesian spending trophy list as the results clearly show unabated spending for both recessions. Ironically, the Bush budget that busted the bank peaked right as Obama took office. Wouldn't this be incredibly un-nerving to Krugman to realize that the largest spending growth occurred in Reagan's administration and Bush II administration?
What about the impact of all the fiat money creation. Wouldn't this show up in our Consumer Price Index? The next chart shows the Consumer Price Index since 1915 and the previously show spending/receipt ratio.
The upper indicator showing CPI shows the turmoil from WWI, depression, and WWII followed by several rapid growth phases post WWII. The period up until the early 70's show stable spending and receipts until the late 70's rapid inflation growth paired with a growth in government spending. But, clearly the fast rise in government spending during Bush term did not produce a rise in our CPI. What happened?
We exported our CPI. Our large growth in debt fueled very high year over year CPI growth rates in foreign countries (notably China). As our imports grew by 19% a year since the mid 80's, the China CPI grew by 6% per year (ouch).
So what exactly are we getting for our money and what does it cost per person? The next chart shows that relationship.
Although a previous chart showed the ever-increasing spending of government, the chart above places the information into a relationship with an individual. The chart uses the growth in population and shows the RESULT of too much spending in terms individuals may understand (how much does it cost ME)? As depicted, WWII cost each individual around 8,000 dollars but through government fiscal responsibility the debt per person reduced to just under $4,000 per person when Reagan took office. Then, one can easily see that Reagan doubled the cost to each individual and Bush II did the same (again, why doesn't Krugman like these guys?). The end result is that our debt per individual stands above $50,000 per U.S. individual.
The next chart highlights a second part of "forward demand" theory. The first has been shown in the previous chart which displays excess government spending for the last 30 years. This next chart shows the savings of individuals (by individual) and what also occurred in the last 30 years.
What jumps immediately in focus is that post WWII, U.S. individuals saved (increasing from $500 per person to around $2,700 in 1984) and government debt remained flat (from 1948 until 1974). Since these numbers have been CPI adjusted, the "responsible" governments (pre Nixon) essentially maintained a stable amount of debt. But the Reagan administration began the profligate spending while savers began to spend increasing amounts. This twofold spending spree clearly shows in the rapid ascent of the S&P 500 Index (which makes perfect sense – both government spending and consumer spending generates high demand for "things" translating into corporate profits).
The last chart for today examines the debt for each individual in an easy term – the 30 year mortgage. What if we took the current debt per person ($53,000) and financed that into a 30 year mortgage. What would the total amount of payments be?
The chart above answers that question. The blue line (left scale) signifies that our 16 Trillion dollar debt by individual financed for 30 years at the current interest rate (under 4 percent) would be roughly $83,000. The red line shows that even during the high interest rates of the early 80's, a 30 year mortgage still would have cost less per individual (roughly $30,000 less) than our current debt.
To circle back to the original premise of article, the last 30 or so years produced a growth stage from two distinct fronts, excess government spending and reduction in individual savings. While none of us know exactly what debt number will upset the apple cart, just knowing that my family of four would have to pay over $320,000 to just pay off the current debt is getting close!
Where Professor Krugman believes that we just have not spent enough from the government purse (our paychecks) – one can hardly believe how we haven't. Where Professor Krugman believes that Republicans are unable to spend, the charts above summarily dismiss that argument (perhaps he just disagrees with where the money is spent). As for David Stockman's belief that both parties are complicit in aggregating irresponsible amounts of debt burdened upon us all – the charts show that Republican and Democratic administrations show no partisanship toward egregious spending habits.
So how does this affect our S&P 500? Governmental austerity (read responsibly) and increased individual savings could provide a double headwind toward future S&P 500 growth similar to the tailwinds of the last 30 years. Additionally, the realization of individual circumstances (i.e. the amount individuals owe toward the debt) could burden corporate profits as well.