Kevin Rudd's Painful Recovery

Kevin Rudd is no economist. In his recent article, The road to recovery (Sydney Morning Herald, 25 July 2009), Rudd has demonstrated he does not understand the current economic depression.

Causes Not Identified

In identifying symptoms of the preceding boom, Rudd thinks he has found the cause. Here are two of the causes Rudd gives for the boom preceding our current economic problems:

First, in many Western countries, the boom was created on a pile of debt held by consumers, corporates and some governments. … Second, these debts were racked up on the back of skyrocketing asset prices. In several countries, stock prices and house values soared far above their true long-term worth, creating paper wealth that millions of households used as collateral for their growing debts.

These are certainly symptoms, but not the cause. Why did people borrow? What caused asset prices to rise? Rudd makes no mention of government central banks suppressing interest rates to record lows, encouraging high borrowing and low saving. Rudd also seems to have no idea that the money creation accompanying these low interest rates caused the artificial growth in asset prices. Rudd also states,

this bubble was fed by a regulatory system that encouraged excessive greed. Weak financial regulation allowed corporate cowboys to take on dangerous financial risks that began to threaten the financial system itself.

After citing two regulations that were relaxed in the United States, Rudd fails to criticise regulations allowing fractional reserve banking which adds tremendous leverage and risk to the financial system. Without fractional reserve banking, there would be no need for an economy-wide government guarantee of bank deposits because all of the depositor’s money would be held by the bank, rather than just a fraction. But Kevin Rudd has no idea about such things, and instead wants to burden the economy with further regulation.

In moving from boom to bust, Rudd orders events this way:

In 2007, this house of cards began to collapse. Asset prices fell, then credit dried up, then growth disappeared, then unemployment skyrocketed. The result: the global economy will shrink for the first time since World War II.

The order is in fact the other way around, credit slows, then asset prices fall. And again, Rudd makes no mention that it was the central bank acting to slow credit by raising interest rates, and that it did this because credit was growing too rapidly at the interest rates it had set in the past.

Intervention a Failure

Faced with this crisis of intervention, Rudd says that:

responsible governments around the world were forced to step in to stabilise fractured financial markets and to support growth and jobs through unprecedented fiscal stimulus.

This ‘stimulus’ has included government guarantees for bank liabilities, government spending programs, and monetary expansion through interest rate reductions.

Rudd boasts that:

Collectively, these government policy actions — fiscal, monetary and financial — amount to the largest and most co-ordinated government stimulus strategy in modern economic history. We have already begun to see the results. Early signs of “green shoots” have emerged in recent economic data.

But these policies have damaged recovery. Government guarantees have enabled investors to ignore risk and have starved capital from other risky investments, and also created a rush to redeem other non-guaranteed assets, encouraging them to freeze redemptions. Government spending programs have destroyed value, and displaced productive jobs with unproductive jobs. Monetary expansion through interest rate cuts has encouraged borrowing and discouraged saving at a time of intense capital shortage, and also set in place the next boom-bust cycle. Any recovery has occurred despite government efforts, not because of them.

Free Market Straw Man Destroyed

Kevin Rudd claims that:

the boom-and-bust economic cycle of the past decade has been an unavoidable consequence of a decade of neo-liberal free market fundamentalism that reinforced a culture of corporate greed and excess in the financial sector. The central principles of this extreme form of capitalism are that markets are self-regulating, that government should get out of the road of the market altogether and that the state itself should retreat to its core historical function of security at home and abroad.

Read that quote carefully. Is Kevin Rudd suggesting we have been enjoying a free market utopia where state responsibilities are restricted to an army, police force, and court system? Ridiculous! There has been no “decade of free market fundamentalism”. This economy is one that is heavily taxed and regulated. We have income tax, consumption tax, company tax, universal health care, welfare, public schooling, military adventures abroad, fiat money, central banking, and financial market regulation. How then can Kevin Rudd blame free market ideals for the fruits of an interventionist economy?

Kevin Rudd is setting up a free market straw man to destroy in order to sell further intervention to the Australian people. This intervention is bound to fail. While the people struggle along with his policies on their back, Kevin Rudd will no doubt take credit for their progress.

Sinclair Davidson has criticised Rudd’s interpretation of the Premiers’ Plan of 1931 in Pictures tell stories (catallaxyfiles, 24 July 2009).

Ross Gittins has also criticised Rudd’s analysis in a more conventional way in Rudd’s new bogy: fearing the pain of recovery (Sydney Morning Herald, 27 July 2009).

© Danny Haynes

- posted 9 August 09 in

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