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Friday February 13, 2009 - 17:04:37 GMT
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Forex Blog - Households and Firms Say Enough!

In my early adult walkabout in Europe, my wife and I visited a fois gras farm outside Bordeaux.  Having slaughtered livestock in my past (infrequently) I was not in the least bit squeamish around working farms where animals are commodities.  Nevertheless I was struck by the image – hanging from the ceiling in the barn were large containers of feed connected to funnels which had leather straps fastened to the heads of geese with broken bills in a several times a day session of forced feeding with one goal in mind…bloating the liver of the geese. 


Yes I still eat fois gras and confit, though admittedly less so in the last year, and I am glad that places like Chicago have overturned bans on this delicacy.   And I hold nothing against the lovely French family that showed us their fois gras farm with joy and pride.  It was the best fois gras I ever tasted…we were invited into their house and served the exquisite food. 


But the image of that day in the barn in the French countryside stuck and it again comes to mind as a visual in light of the discussion over getting banks to lend and more importantly households and firms to borrow for consumption and investment.


Context is everything…firms do not need bank loans to expand capacity…they need bank loans to tide them over to better times or if they are overleveraged they really don’t need loans at any price other than ones for debt restructuring/consolidation.  Household balance sheets on balance are far worse.  Cheap credit fuelled a massive wave of consumption that borrowed from future consumption and needs to revert to the mean.  Firms and households are like the geese in that French barn…they don’t want or need any new debt to finance consumption.  They, like firms, need low cost loans to replace higher cost loans, taking the difference to pay down debt and save, not spend. 


Yes a functioning banking system (and shadow bank system) is essential for any recovery to take hold.  But force feeding households and firms stuffed to the gills on a decade of cheap credit and massive consumption by households and massive investment by some firms is pushing on a string.  No amount of wishing a return of risk seeking behavior for households and firms is going to get the bloated goose to eat more corn.  A liquidity trap is all about no demand for money in a world flush with money. 


This is why the ideologues on the right are misguided (and some on the left) when calling for tax cuts over government spending…a dollar of a tax cut in the current economic environment (fiscal policy needs to be made in the context of the business cycle not fixed rules and surely not supply side fantasies) is going to yield < a dollar of spending and < a dollar for GDP.  A dollar of government spending is going to lead to a dollar of spending for GDP.  When the private sector is withdrawing from spending and investing in the dramatic degree we are currently witnessing, the government can or cannot fill the void.  If it does not, the deflationary spiral that is assured will leave GDP even more in the red and unemployment more in the black, making government fiscal deficits even larger if $800bln is thrown into GDP (well in this bill a lot less as it includes tax cuts when it should not have any tax cuts). 


I am not opposed to tax cuts (or tax hikes)…they have their place and time…just not now.  There are appropriate times to starve government with tax cuts…just not now.

David Gilmore   



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