Paul Krugman describes what he calls the Doom Loop – the process wherein political elites are radically (and potentially deliberately) misinterpreting signals from financial markets to enact destructive policies.
1. US debt is downgraded, sparking demands for more ill-advised fiscal austerity
2. Fears that this austerity will depress the economy send stocks down
3. Politicians and pundits declare that worries about US solvency are the culprit, even though interest rates have actually plunged
4. This leads to calls for even more ill-advised austerity, which sends us back to #2
Krugman points out that this loop and the people who are giving it energy are “impervious to evidence.”
Ben White of Politico noted in his daily tip sheet today essentially the same phenomenon:
Moving between NYC and DC as I do it can be jarring at times to hear politicians in Washington talking endlessly about markets demanding that the U.S. focus on spending and deficit and debt reduction. Then I come back to New York and such talk is simply laughed at given rock-bottom Treasury yields and the commonly held (and correct) view that the U.S. does not have much of a debt problem, certainly not in the near term. But it has a MASSIVE and potentially disastrous growth problem.
That’s why traders often mute the TV (or start cursing) when President Obama begins talking about super committees and shared sacrifice and tax hikes. To be fair, they mute GOP leadership as well. It’s hard to recall a time when the debate and rhetoric in Washington seemed more completely disconnected from what is actually going on in markets and the economy.
There’s a disconnect, to be sure. But it’s driven by ideology. People who believe that austerity should happen and that austerity is the only tool in their tool chest will seek out and find reasons for austerity to be deployed, regardless of whether they are right or not.