Krugman Says U.S. Economy Is Facing a ‘Long Siege’ (Update1)

By Bob Willis and Carol Massar
July 6 (Bloomberg) -- Nobel Prize-winning economist Paul Krugman said the U.S. should have a "kitchen-sink strategy"
that uses all fiscal and monetary policies possible to prevent the economy from sliding back into a recession.
"We are looking at what could be a very long siege here,"
Krugman said in an interview today in Princeton, New Jersey, with Carol Massar of Bloomberg Television’s "Street Smart."
"We really are at a stage where we should have a kitchen-sink strategy. We should be throwing everything we can get at this."
At a time when European countries such as Germany are calling for austerity measures to rein in budget deficits, Krugman is calling for more stimulus to prevent a repeat in the U.S. of Japan’s decade of economic malaise in the 1990s.
"The most effective things you can do, in terms of actual bang for the buck, is actually having the federal government go out and hire people," he said. "We are deep in the hole here, and you need to be unconventional to get out of it."
He said too many policy makers and commentators are overly concerned that the ballooning U.S. deficit would set off a crisis of confidence similar to Europe’s sovereign debt crisis.
Krugman said he’s concerned U.S. policy makers would be unable to agree to short-term stimulus for the economy along with long- term measures to curtail the deficit.
"I worry about the politics," he said. "I worry about our ability to get a consensus to do the pretty straight-forward things we need to do to balance our budget in the long run."

Long-Term Deficits

The projected U.S. budget gap in 10 years can be brought under control with a "combination of modest tax increases and reasonable spending cuts," particularly on health care, Krugman said, adding it’s "extremely unlikely" the U.S. would ever default on its debt.
"I’m not aware of any example of a country that got into fiscal difficulty because it began a stimulus program and couldn’t take away the stimulus program," he said. "If you’re serious about fiscal responsibility, you should not be saying, ‘let’s skimp on aid to the economy in the middle of a financial crisis.’"
Krugman forecast the economy will grow at about a 1 percent pace or slightly faster within six months, and that job growth would be less than the rate of growth of the population. He said in six months, the U.S. would be facing a "labor market that’s getting worse not better."

Job Gains

The U.S. Labor Department reported last week that employment fell by 125,000 workers in June, the first jobs decline this year, because of layoffs of temporary census workers. Private companies added 83,000 people, a smaller-than- forecast gain that capped a month of data indicating weakness in industries from housing to manufacturing.
Other reports last month showed a plunge in home sales, a slump in consumer confidence, cooler manufacturing and less growth in the first quarter.
The lack of jobs will curtail consumer spending, which accounts for about 70 percent of the world’s largest economy, and restrain sales at retailers including Barnes & Noble Inc.
The rebound from the worst recession since the 1930s faces risks from the European debt crisis and slower growth in China at the same time that fiscal stimulus measures fade.
"We are, I think, sliding into a situation where we’re likely to see several bad years ahead," Krugman said. "Given what I see in the political process, the odds are against us avoiding a really prolonged bad period."

I'll take this as the growth argument. More to your point Sauros.

Batman wrote:

I'll take this as the growth argument. More to your point Sauros.

It's always more convincing when written in good English by a Nobel Prize winner uh ?

Sauros wrote:

Batman wrote:

I'll take this as the growth argument. More to your point Sauros.

It's always more convincing when written in good English by a Nobel Prize winner uh ?

I always like reading scholarly articles However, I prefer Trader Speak.

Here is an interesting view from Soros. The article is dated June 24th. Nonetheless, the Hungarian Philanthropist lets us know what he thinks of the debate between growth and austerity.

Via FT Op-Ed:

Germany used to be at the heart of European integration. Its statesmen used to assert that Germany had no independent foreign policy, only a European policy. After the fall of the Berlin Wall, its leaders realised that German reunification was possible only in the context of a united Europe, and they were willing to make some sacrifices to secure European acceptance. Germans would contribute a little more and take a little less than others, thereby facilitating agreement. Those days are over. The euro is in crisis, and Germany is the main protagonist. Germans don’t feel so rich any more, so they don’t want to continue serving as the deep pocket for the rest of Europe. This change in attitude is understandable, but it has brought the European integration process to a halt.

By design, the euro was an incomplete currency at its launch. The Maastricht treaty established a monetary union without a political union – a central bank, but no central treasury. When it came to sovereign credit, eurozone members were on their own. This fact was obscured until recently by the European Central Bank’s willingness to accept the sovereign debt of all eurozone members on equal terms at its discount window. As a result, they all could borrow at practically the same interest rate as Germany. The banks were happy to earn a few extra pennies on supposedly risk-free assets and loaded up their balance sheets with the weaker countries’ government debt. The first sign of trouble came after the collapse of Lehman Brothers in September 2008, when the European Union’s finance ministers decided, at an emergency meeting in Paris that October, to provide a virtual guarantee that no other systemically important financial institution would be allowed to default. But German chancellor Angela Merkel opposed a joint EU-wide guarantee; each country had to take care of its own banks.

At first, financial markets were so impressed by the guarantee that they hardly noticed the difference. Capital fled from the countries that were not in a position to offer similar guarantees, but interest-rate differentials within the eurozone remained minimal. That was when countries in eastern Europe, notably Hungary and the Baltic states, got into trouble and had to be rescued. It was only this year, when financial markets started to worry about the accumulation of sovereign debt, that interest-rate differentials began to widen. Greece became the centre of attention when its new government revealed that its predecessors had lied about the size of the 2009 budget deficit. European authorities were slow to react, because eurozone members held radically different views. France and other countries were willing to show solidarity, but Germany, traumatised twice in the 20th century by runaway prices, was allergic to any build-up of inflationary pressures. (Indeed, when Germany agreed to adopt the euro, it insisted on strong safeguards to maintain the new currency’ s value, and its constitutional court has reaffirmed the Maastricht treaty’s prohibition of bail-outs.)

Moreover, German politicians, facing a general election in September 2009, procrastinated. The Greek crisis festered and spread to other deficit countries. When European leaders finally acted, they had to provide a much larger rescue package than would have been necessary had they moved earlier. Moreover, in order to reassure the markets, the authorities felt obliged to create the €750bnEuropean Financial Stabilisation Facility, with €500bn from the member states and €250bn from the International Monetary Fund. But the markets have not been reassured, because Germany dictated the terms of the rescue and made them somewhat punitive. Moreover, investors correctly recognise that cutting deficits at a time of high unemployment will merely increase unemployment, making fiscal consolidation that much harder. Even if the budget targets could be met, it is difficult to see how these countries could regain competitiveness and revive growth. In the absence of exchange rate depreciation, the adjustment process will depress wages and prices, raising the spectre of deflation. The policies currently being imposed on the eurozone directly contradict the lessons learnt from the Great Depression of the 1930s, and risk pushing Europe into a period of prolonged stagnation or worse. That, in turn, would generate discontent and social unrest. In a worst case scenario, the EU could be paralysed or destroyed by the rise of xenophobic and nationalist extremism.

If that were to happen, Germany would bear a major share of the responsibility. Germany cannot be blamed for wanting a strong currency and a balanced budget, but as the strongest and most creditworthy country, it is unwittingly imposing its deflationary policies on the rest of the eurozone. The German public is unlikely to recognise the harm German policies are doing to the rest of Europe because, the way the euro works, deflation will serve to make Germany more competitive on world markets, while pushing the weaker countries further into depression and increasing the burden of their debt. Germans should consider the following thought experiment: withdrawal from the euro. The restored Deutschemark would soar, the euro would plummet. The rest of Europe would become competitive and could grow its way out of its difficulties but Germany would find out how painful it can be to have an overvalued currency. Its trade balance would turn negative, and there would be widespread unemployment. Banks would suffer severe losses on exchange rates and require large injections of public funds. But the government would find it politically more acceptable to rescue German banks than Greece or Spain. And there would be other compensations; German pensioners could retire to Spain and live like kings, helping Spanish real estate to recover.

Of course, this is purely hypothetical because, if Germany were to leave the euro, the political consequences would be unthinkable. But the thought experiment may be useful in preventing the unthinkable from actually happening.

The writer is chairman of Soros Fund Management

Batman wrote:

Sauros wrote:

Batman wrote:

I'll take this as the growth argument. More to your point Sauros.

It's always more convincing when written in good English by a Nobel Prize winner uh ?

I always like reading scholarly articles However, I prefer Trader Speak.

Here is an interesting view from Soros. The article is dated June 24th. Nonetheless, the Hungarian Philanthropist lets us know what he thinks of the debate between growth and austerity.

Via FT Op-Ed:

Germany used to be at the heart of European integration. Its statesmen used to assert that Germany had no independent foreign policy, only a European policy. After the fall of the Berlin Wall, its leaders realised that German reunification was possible only in the context of a united Europe, and they were willing to make some sacrifices to secure European acceptance. Germans would contribute a little more and take a little less than others, thereby facilitating agreement. Those days are over. The euro is in crisis, and Germany is the main protagonist. Germans don’t feel so rich any more, so they don’t want to continue serving as the deep pocket for the rest of Europe. This change in attitude is understandable, but it has brought the European integration process to a halt.

By design, the euro was an incomplete currency at its launch. The Maastricht treaty established a monetary union without a political union – a central bank, but no central treasury. When it came to sovereign credit, eurozone members were on their own. This fact was obscured until recently by the European Central Bank’s willingness to accept the sovereign debt of all eurozone members on equal terms at its discount window. As a result, they all could borrow at practically the same interest rate as Germany. The banks were happy to earn a few extra pennies on supposedly risk-free assets and loaded up their balance sheets with the weaker countries’ government debt. The first sign of trouble came after the collapse of Lehman Brothers in September 2008, when the European Union’s finance ministers decided, at an emergency meeting in Paris that October, to provide a virtual guarantee that no other systemically important financial institution would be allowed to default. But German chancellor Angela Merkel opposed a joint EU-wide guarantee; each country had to take care of its own banks.

At first, financial markets were so impressed by the guarantee that they hardly noticed the difference. Capital fled from the countries that were not in a position to offer similar guarantees, but interest-rate differentials within the eurozone remained minimal. That was when countries in eastern Europe, notably Hungary and the Baltic states, got into trouble and had to be rescued. It was only this year, when financial markets started to worry about the accumulation of sovereign debt, that interest-rate differentials began to widen. Greece became the centre of attention when its new government revealed that its predecessors had lied about the size of the 2009 budget deficit. European authorities were slow to react, because eurozone members held radically different views. France and other countries were willing to show solidarity, but Germany, traumatised twice in the 20th century by runaway prices, was allergic to any build-up of inflationary pressures. (Indeed, when Germany agreed to adopt the euro, it insisted on strong safeguards to maintain the new currency’ s value, and its constitutional court has reaffirmed the Maastricht treaty’s prohibition of bail-outs.)

Moreover, German politicians, facing a general election in September 2009, procrastinated. The Greek crisis festered and spread to other deficit countries. When European leaders finally acted, they had to provide a much larger rescue package than would have been necessary had they moved earlier. Moreover, in order to reassure the markets, the authorities felt obliged to create the €750bnEuropean Financial Stabilisation Facility, with €500bn from the member states and €250bn from the International Monetary Fund. But the markets have not been reassured, because Germany dictated the terms of the rescue and made them somewhat punitive. Moreover, investors correctly recognise that cutting deficits at a time of high unemployment will merely increase unemployment, making fiscal consolidation that much harder. Even if the budget targets could be met, it is difficult to see how these countries could regain competitiveness and revive growth. In the absence of exchange rate depreciation, the adjustment process will depress wages and prices, raising the spectre of deflation. The policies currently being imposed on the eurozone directly contradict the lessons learnt from the Great Depression of the 1930s, and risk pushing Europe into a period of prolonged stagnation or worse. That, in turn, would generate discontent and social unrest. In a worst case scenario, the EU could be paralysed or destroyed by the rise of xenophobic and nationalist extremism.

If that were to happen, Germany would bear a major share of the responsibility. Germany cannot be blamed for wanting a strong currency and a balanced budget, but as the strongest and most creditworthy country, it is unwittingly imposing its deflationary policies on the rest of the eurozone. The German public is unlikely to recognise the harm German policies are doing to the rest of Europe because, the way the euro works, deflation will serve to make Germany more competitive on world markets, while pushing the weaker countries further into depression and increasing the burden of their debt. Germans should consider the following thought experiment: withdrawal from the euro. The restored Deutschemark would soar, the euro would plummet. The rest of Europe would become competitive and could grow its way out of its difficulties but Germany would find out how painful it can be to have an overvalued currency. Its trade balance would turn negative, and there would be widespread unemployment. Banks would suffer severe losses on exchange rates and require large injections of public funds. But the government would find it politically more acceptable to rescue German banks than Greece or Spain. And there would be other compensations; German pensioners could retire to Spain and live like kings, helping Spanish real estate to recover.

Of course, this is purely hypothetical because, if Germany were to leave the euro, the political consequences would be unthinkable. But the thought experiment may be useful in preventing the unthinkable from actually happening.

The writer is chairman of Soros Fund Management

Well we all know germany is not gonna be leaving the EUR, There should be more focus on the relative performance of all the smaller parts (countries) to work with Germany in improving the overall structure. depending too much on one country is the same as the diversification problem. Too much concentration and you get high risk, the same applies in the sovereign sense.