We’re all saved. Big Government has avoided the second great depression. That is, if you believe Nobel-Prize winning New York Times commentator, Paul Krugman – and worldwide share markets.

Krugman wrote recently in the New York Times that:

So what saved us from a full replay of the Great Depression? The answer, almost surely, lies in the very different role played by government…In addition to having this “automatic” stabilising effect, the government has stepped in to rescue the financial sector.

You can argue (and I would) that the bailouts of financial firms could and should have been handled better, that taxpayers have paid too much and received too little. Yet it’s possible to be dissatisfied, even angry, about the way the financial bailouts have worked while acknowledging that without these bailouts things would have been much worse.

The point is that this time, unlike in the 1930s, the government didn’t take a hands-off attitude while much of the banking system collapsed. And that’s another reason we’re not living through Great Depression II.

Being a Nobel Prize winner gives Krugman a degree of authority (of course, the same could have been said for 1997 Nobel winners, Myron Scholes and Robert Merton, but they didn’t fare too well at the collapsed hedge fund, Long-Term Capital Management). If you consider global stock markets and confidence surveys, it appears that Krugman’s views are correct — stocks have rebounded almost 50% from the March lows. Of course, this also happened in 1930, before the Dow fell another 75% in 1932. The full recovery ultimately took a world war and twenty years.

There is also doubt whether temporary government stimulus aimed at increasing consumer spending is beneficial or detrimental to the economy — and specifically, living standards. Simply because GDP has increases (as Japan’s did yesterday, and Australia’s did in the June quarter, thereby avoiding a technical recession) does not mean the stimulus has actually worked. GDP growth is based largely on consumer spending — by borrowing, one can bring forward future spending (thereby improving economic data), but not actually creating lasting growth. (If you spend $10,000 on a holiday using monies borrowed on credit, you have improved your current ‘spending’ and lifestyle, but will be paying for it for years to come).

In Japan, while growth figures release earlier this week indicated that the economy grew at an annualised rate of 3.6% last quarter, investment actually fell. That means people are buying goods and services which gives them short-term pleasure, but not investing in other means of production which would increase production capacity or and crucially, the technological development of a nation. On recent figures, it appears that Japan is morphing into the United States.

In Australia, the Federal Government has handed out billions of dollars (in reality, the handouts are really a grossly inefficient wealth transfer from one group of people to another) to encourage spending. Much of this spending found its way into the pockets of poker machine operators and plasma television sellers (witness JB Hi Fi’s extraordinary profit growth) — it also led to a rise in headline ‘consumer spending’ and thus, GDP. Other government money was provided to first home buyers, who promptly used the grant to increase borrowings and overpay for houses.

Effectively, the Government was handing money to people selling properties. While GDP rose, and share prices flourished, no lasting economic benefits have been created. Just a pile of debt that eventually needs to be repaid. Fortunately for the Government who is handing out taxpayers’ money, it will be repaid by people who by and large, won’t be voting at the next election and has been given to people who will be voting next year.

The US stimulus payment have been even more misguided — hundreds of billions of dollars have been handed to failed, risk taking banks like Citigroup and Bank of America. (The banks promptly used a sizable percentage of these monies to pay high-flying staff billions of dollars of bonuses). Almost $100 billion has also been provided to AIG, although that had the important benefit of helping Henry Paulson’s old friends at Goldman Sachs (AIG owed Goldmans US$13 billion).

Both the US Government and Australian Government have provided billions of dollars to stimulate the automobile industry (in Australia, new car buyers have received generous cash discounts in the form of investment allowance — in the US, the government pays thousands of dollars for clunkers). While new cars have electric windows, they do not provide real economic benefit, in the same sense as say, a new public transportation system.

Not all Keynesian-style stimulus is a bad thing — if governments are able to spend taxpayer funds creating investment and long-term employment in sustainable industries, it is certainly preferable to paying those same monies out as unemployment benefits. However, when Government spending causes distortions, favours certain groups (like the automobile industry who are a powerful lobby group, or first home buyers, who are a powerful voting group) that causes more problems than it solves.

Sharemarkets are rarely correct (unless you believe in the efficient market hypothesis, which would make you a university lecturer or a fool). They tend to dramatically overreact or under-react to fundamental data. The recent share-market recovery and positive economic data has given rise to confidence that the worst is over — however, if you believe that history repeats, or that politically targeted borrowing doesn’t create real wealth, then be very wary of this so-called recovery, no matter what Nobel-prize winning economists might say.