Spain Is Depressed

Europe is hurting from the economic slow down but Spain is looking at a depression.

Falling exports will hit Germany hard. Europe's largest economy is also the world's biggest exporter and will likely shrink 2.3 percent this year, it said. German Finance Minister Peer Steinbrueck said this chimed with Berlin's own figures.

A sharp German slowdown will hit its nearest neighbors and trading partners.

The EU says the British economy will also shrink, about 2.8 percent this year, as the financial sector contracts and a housing bubble deflates, while France will contract by 1.8 percent.

Spain and Ireland will also suffer sharply as recent booms go bust and jobless queues lengthen -- with nearly one in five Spanish workers without a job by 2010.

Twenty percent unemployment is at depression levels. Spain is one of the Euro Group hardest hit by the housing bubble.

So what does the future hold? Some economists are predicting a bottom around the second quarter of 2009. Others say that the pick up will not start until well into 2010. And how will that effect the American scene? It depends. If the American Congress tries to spend the US economy out of the recession the economy will stagnate.

Alyssa A. Lappen agrees with me.

...cheap credit does not spur new investment or economic growth. In his 1993 study of more than 5,000 U.S. manufacturing companies from 1971 to 1990, economics professor Steven Fazari found that business invest based on overall economic health and the growth in their own sales and profits. “Weakness in the economy is more likely to reduce investment than lower interest rates are to stimulate it.” But low rates can and will spring like a jack knife if and when investors find other outlets for their “easy” liquidity-induced cash.

Note that businesses invest based on sales and profits. And what is the fastest way to increase business profits? Lower business taxes. This allows business to decide the proper balance between lower prices and increased profits.

So how have countries fared that tried to spend their way out of financial difficulties? We have Japan as a sub prime example.

U.S. taxpayers still face the extraordinary deficit burden already heaped upon them---and only likely to grow under the Obama administration. As Melloan noted, in the 1990s, “Japan tried to spend its way out of its post bubble malaise,” but merely accumulated “a mountain of debt” and lost a decade to “little or no economic growth.”

Even if the national deficit increases no further, national debt would grow more onerous in the case of a Great Depression-like deflation tornado, such as shredded the U.S. economy and in 1933 raised unemployment to 24%. The debt will remain the same or even grow until it is paid off, while incomes and the tax base shrink. Keep in mind, as in 1933, interest rates and stocks have already declined steeply.

Moreover, to cover the U.S. deficit, taxes will certainly rise. In an inflationary environment, those new taxes could broadly pass to willing (or resigned) consumers. Now, however, in a contracting economy, they must be spread more narrowly to shrinking companies and a shrinking pool of workers. Companies are likely to respond by further slashing jobs, thus adding to the very grave potential for a deflationary spiral.

So are the Republicans starting to get it? If the economy needs stimulating what is the best way? Government direct spending or lowering government income while increasing business income? The Republicans have some ideas. Rep. David Dreier (R), of the San Gabriel Valley in California is one of those idea men.

Dreier outlined his priorities Thursday in an interview with the Tribune on Capital Hill for what, under Obama's plan, has ballooned to nearly a trillion-dollar economic stimulus package that Obama.

Obama's outline includes investments in infrastructure and public works improvements, investments in green technology and tax cuts and credits for working families and businesses.

All of which will cost about $800 billion, his economic team has said.

But while committing support to some kind of plan, Dreier and other Republicans this week stressed that increased government spending is no guarantee of bringing the nation out of its deep recession.

They urged care in crafting bipartisan legislation that balances government spending with incentives for business and tax cuts that they say will increase spending and revive the economy.

Dreier's ideas include:

Reducing marginal tax rates; Offering tax credits to homebuyers; and Getting consumers into auto dealerships' showrooms.

"We have found that throughout the history... marginal rate reduction stimulates economic growth and leads to an increase in the flow of revenues to the federal Treasury," Dreier said.

That would include reducing the top rate on businesses from 35 percent to 25 percent, and reducing the capital gains tax to 15 percent, while eliminating the death tax, he said.

"There are so many business that have to be sold because of that tax," he said.

Now I don't agree with all the proposals, but you do have to get bills passed and a few stupid ideas help to insure passage. The essential thing is this: if the government is going to put a lot of money in the economy it has to do something that will increase production in order to keep inflation in check otherwise consumers will just bid up the price of goods and there will be a new bubble to deal with. Prices have to come down to what consumers are willing to spend. That means lowering the cost of doing business or increasing production. Lower taxes on business will give businesses the opportunity to decide in each case what the best policy is.

So will the new President and Congress do something totally stupid? Well Mark Twain had a handle on it:

"Suppose you were an idiot, and suppose you were a member of Congress; but I repeat myself."

My expectations are limited so that gives me an advantage right there. Any move in a useful direction will seem miraculous to me.

Cross Posted at Classical Values