Ferguson, Roubini vs. Krugman: Slowdown or depression for the U.S.?

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This post is a guest contribution by Dian Chu, market analyst, trader and author of the Economic Forecasts and Opinions blog.

Paul Krugman, a strong supporter of fiat money, is obviously having major distress over the G20 push to cut deficits in half by 2013 and stabilize the soaring U.S. debt.  In his latest New York Times column, Krugman not only criticizes austerity measures, but also asserts that we are in the early stages of a third depression as a direct result of the spending cut.

Perhaps because Krugman beat him to the punch with this ultimate Doomsday op-ed piece, on this very rare occasion Dr. Doom − Nouriel Roubini − is actually a lot more optimistic about the economy in the United States when he spoke with CNBC last night (watch the clip here).

Roubini − No Recession in the U.S.
In The Kudlow Report, Roubini says he does not see a double-dip recession in the U.S.  Rather, the U.S. will experience a slowdown of around 1.5% GDP in the second half of this year, after growing 3% in the first half, he says.

At the same time, keeping up with his Dr. Doom reputation, Roubini does see a recession coming in the euro zone and Japan.  There is a risk of a contagion effect to the U.S., which could lead to further correction in stock prices with a double-dip in Europe, Japan “falling off the cliff”, and evidence of a slowdown in China.

Meeting Krugman sort of halfway, Roubini thinks fiscal austerity is needed in Greece, Spain and Portugal, whereas countries like Germany, Japan and China should be doing fiscal stimulus.

Ferguson Worries about European Banks & U.S. Fiscal Roubini’s view is also shared by Harvard University professor Niall Ferguson, who told CNBC in a separate interview that

“Right now the picture is definitely bleaker in Europe than it is in the U.S. … I agree with Nouriel on this, it’s not as if the U.S. economy will contract, it will grow at a slower rate.”

In addition to the debt woes in Europe, Ferguson is “nervous” about European banks, which are more leveraged than U.S. banks.  He noted the European governments do not have “very deep pockets” as most people have assumed, and the Greek crisis revealed the limit of this largesse.

Even though, compared with the euro zone, the economic picture in the U.S. does look relatively better, Ferguson said the horrendous fiscal situation means the U.S. is likely to be faced with tough measures to cut the deficit over the longer term.

My Take − Difficult Balancing Act
Based on my biflation analysis I believe the risk of deflation, not to mention depression, is highly overstated.  As such, I don’t see the U.S. going into another recession either, albeit slow and anemic growth into 2011 or 2012.

On the other hand, the U.S. deficit situation is not something that could be rectified by more spending, as suggested by Krugman.

Bloomberg’s chart published on June 4 (below) shows the U.S. government’s total debt, which rose past $13 trillion for the first time this month, will surpass GDP in 2012, based on forecasts by the International Monetary Fund (IMF).

In a report for the Toronto summit, the IMF suggests “growth-friendly” policies such as shifting from income and payroll taxes to consumption taxes. In the United States, that might mean adopting a value-added tax (VAT) of up to 8% on all goods and services.

In the state of Texas, where there’s no state income tax, the sales tax rate in the City of

Houston is already at 8.25%.  So, from my perspective, VAT would seem a path of least resistance to raise revenue rather than an income tax add or hike.

The idea of a VAT actually has gained some traction, including the support of President Obama’s economic advisor, Paul A. Volcker.  However, the recent debate in Washington has become more focused on cutting social security, health benefits, defense spending and the freezing of other government programs.

Meanwhile, the employment malaise (see chart) suggests that as far as job creation is concerned, we might need a second stimulus spending since the first one was basically squandered away.  But Congress will likely balk at the added expense in an election year.

So, from all indications, it seems the U.S. most likely will only start slashing spending and implementing necessary measures − with some degrees of urgency − when coming under pressure from bond markets, similar to Greece and Spain.

Fortunately, and unfortunately, one luxury of being such a big spender is that the U.S. practically holds its debtors hostage.

Nevertheless, the day of reckoning could be coming, probably as soon as the euro zone comes out of this crisis … one way or another.

Quote of the Day:

“People like Krugman living in glass towers at the New York Times or Princeton University need to understand that deficits do matter.”  ~ Niall Ferguson.

Source: Dian Chu, Economic Forecasts and Opinions, June 30, 2010.

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2 comments to Ferguson, Roubini vs. Krugman: Slowdown or depression for the U.S.?

  • Justin

    Wishful thinking? To suggest that we are going to be able to produce enough revenue through a VAT tax, while 22% unemployment is the norm. What happens when the unemployment checks really stop coming? Won’t those keeping the credit card companies, and mortgage companies at bay have to default? Not to mention those that run out of time, squatting in their own homes, and end up getting kicked to the curb and have to start paying rent? Raising taxes on top of already high taxes at this time seems like a bad idea.

  • D'pressed

    Fake stimulus recovery = severe economic Depression.

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