The Broken Window Fallacy

Paul Krugman, who once said that 9-11 could do some economic good never seems to astound me. He has company. Larry Summers believes in the broken window fallacy, period. I recall Summers saying that the Japan earthquake may lead to temporary GDP increments. Firstly, this was a tragedy and our thoughts are with the people who have suffered in this quake, but this is the problem when we have a distorted view of what economic growth is.

Indiscriminate spending does not contribute to economic growth. One has to recognise that the spending that will ensue to rebuild Japan will not contribute to the productive capacity of the nation; rebuilding Japan will require increased borrowing from Japanese citizens to rebuild buildings and infrastruture that were already functioning and efficient. So this will not contribute to GDP growth but it will add to their structural deficit and heighten their bond market awakening.

Chart of the Day – US 1 Year CDS price more expensive than Indonesia and Slovenia!

Market whispers are creeping up and there seems to be some increased concerns over a US default as budget talks continue between Democrats and Republicans. CNBC Asia reported earlier that US 1 Year CDS rates are currently higher than Indonesia and Slovenia. G8 leaders are also meeting in France to discuss a wide range of pressing financial issues. US 1 Year CDS trade volumes however remain minute relative to the total US debt outstanding.

Source: Markit

Another interesting point is that the price of the US 1 year Treasury yield is currently 0.18%, which is almost at the lowest rate year-to-date. Mr Market is sending mixed signals.