The Wrong Rebound

Armies are notorious for fighting the last war.  Struggling to prepare for new threats, they are blinded by the former threats they faced, the last war they finished learning to fight.

We all tend to have the same problem.  It is the other side of learning from experience.  Once we have learned something, we assume we know it and are locked into familiar knowledge.

Right now, in the aftermath of the credit bubble, governments are mesmerized by the threat of excessive debt – a point that has recently been emphasized by Nouriel Roubini.  Known as Dr. Doom for his predictions that the financial markets, dangerously over-extended three and four years ago were, bound to collapse, he has acquired significantly more credibility today.  Then he was mocked as a Cassandra, out of step with the rest of the financial world.  Now he’s known, like Cassandra, to have been right all along.

Writing on his own website, he notes that we have become preoccupied by the risk of debt, the danger we are still struggling to recover from:  “a combination of high oil and commodity prices, turmoil in the Middle East, Japan’s earthquake and tsunami, eurozone debt crises, and America’s fiscal problems (and now its rating downgrade) have led to a massive increase in risk aversion.”

But, now, the problem we are facing is different:  “Economically, the United States, the eurozone, the United Kingdom, and Japan are all idling. Even fast-growing emerging markets (China, emerging Asia, and Latin America), and export-oriented economies that rely on these markets (Germany and resource-rich Australia), are experiencing sharp slowdowns.”

The result:  “Fiscal policy currently is a drag on economic growth in both the eurozone and the UK. Even in the US, state and local governments, and now the federal government, are cutting expenditure and reducing transfer payments. Soon enough, they will be raising taxes.” (See, “Is Capitalism Doomed?”)

Others have been making a similar point about our need to stimulate the economy.  But “Dr. Doom” has the benefit of having been excoriated in the past for observations and predictions that were as obvious then as they seem to be now.  He not only knows his economics, he knows his mob psychology, and he is not inhibited.

But that doesn’t mean he is being listened to.  Many investors who think they are following the money are actually following the crowd.  And the crowd in this case is focused on the political goals of cutting back government and eliminating services for the poor.  That isn’t always smart economics.