The last few days, I’ve been reading various opinions on the US Economy on the web, and thinking that they don’t really get the situation that we are in, both short- and long-term.? I am increasingly disappointed with those proposing Keynesian remedies, because those were what got us into this pickle in the first place, and they think that more of the “hair of the dog” will rescue us from our drunkeness.
Consider, when in the last 40 years has our government not run a deficit, excluding flows from entitlement programs?? I think the answer is has never been so.? Stimulus has been the rule, the only argument has been do we do more or less?
Think of monetary policy post-Volcker.? Who has been willing to allow a recession to harm marginal investments?? No one.? The punch bowl was removed slowly, but brought back rapidly, which brought the applause of politicians, and gave Greenspan the moniker “Maestro,” even though he was driving us into a liquidity trap.? (Maestro, yuck: I’m a gentleman; I can’t express what a disgrace it is to lionize a man who did us such harm.? Execution is out of the question, but can we send him to the North Koreans or the Iranians to have him run their monetary policy?)
Bernanke is little different, having learned the wrong lessons from the Great Depression, thinking that the response from the Central Bank and the Government was too weak.? Rather, they did too much, and prolonged the depression more than it would have otherwise gone.? Andrew Mellon was wiser than them all.
Governments are bad allocators of capital.? They borrow money and allocate it to where the political return is the highest.? Those projects may bump up GDP in that year but do little for future GDP.? This is the lie of C+I+G=Y.? Yes, in the short run that works, but in the long run, money spent by consumers and investors yields far more for growth in the economy than government spending.? Our government is only interested in the short run, given their short-run fixation on the election cycle.
Consumers choose what helps them in the short-run, and Investors the long-run.? The government has non-economic motives — their actions merely harm the situation.? Better they should reduce taxes broadly than try to target certain areas that have clever lobbyists.
All that said, I believe government has a role in regulating commerce.? There have to be standards established so that that people can trust in what they buy, in areas that cannot be easily verified by ordinary people.
The Four Roads
There are four roads ahead for our economy, thought they are not all exclusive, aside from default.? Let me describe them:
Higher Taxes
This is the solution of the aftermath of the Great Depression.? After the huge debt buildup from the depression, the increase in taxes paid off the the debts in the 50s.? Problem: baby boomers and their children are more selfish, and won’t take the same abuse today.
All that said, be ready for higher taxes.
Inflation
At present the Federal Reserve will not stimulate goods-price inflation.? They will support asset inflation; consider how they supported the money markets when they were under stress.
But there may be a limit to their ability to control matters.
Default
The US Government could never default.? Well it did twice, under Roosevelt and Nixon, when it moved away from its gold-based obligations.
Government receipts would have to double to meet the future needs of entitlement programs.? I don’t think we can get there.? More likely we try to reduce payments, even if already agreed to.
Japan
The Japan scenario means survival.? Rather than taking a deserved depression, the economy is forced to support lousy companies that cannot survive otherwise.? They have done that for 20 years.
The Point
My view is that we are going to take deflationary pain anyway, so take it like men (are there men nowadays?). ? There may be institutions that fail; far better to deal with them at the most basic level, that of the debtor, than trying to prop up dud institutions.
I have more to say, but I have to go backpacking.? More later.
“Governments are bad allocators of capital. They borrow money and allocate it to where the political return is the highest. ” awesomely simple summary of the situation. quote of the day for sure!
One has to be pretty uninformed if you believe Mellon’s advice wasn’t followed for all the denials it was. Yeah let’s have another Great Depression, one wasn’t enough. That will teach those greedy lenders.
I agree David. Short-term pain for long-term gain,
not short-term gain for long-term pain.
The first statement is the definition of sanity, the second insanity.
I’m all for accepting the pain now and purging malinvestments. So in the main I agree with the policy advice, though I’m not sure I entirely agree with this:
“Bernanke is little different, having learned the wrong lessons from the Great Depression, thinking that the response from the Central Bank and the Government was too weak. Rather, they did too much, and prolonged the depression more than it would have otherwise gone.”
The Federal Reserve expanded credit too much prior to the Great Depression, and so paved the way for a serious correction. But once the correction began, velocity plummeted, and I think there’s a decent case (made by Selgin and White) that the Fed should have significantly enlarged the monetary base, to prevent a collapse in nominal income. They shouldn’t have tried to thwart relative price adjustments, but little is gained by letting the general price level fall precipitously. FWIW, Robbins later in life had serious regrets about not calling for offsetting expansionary policies to combat deflation, and Hayek too seems to have had some regrets. If they were alive today, I think they’d have opposed the Greenspan Put from the beginning, as well as the Congressional Bailouts, and they wouldn’t at all have liked the targeted lending Bernanke has done. But my guess is, rather than supporting a weak response by the Fed to the financial crisis, they’d have taken a position like Jeffrey Lacker’s, and advocated for an initial large scale monetary expansion.
David, could you elaborate on this point some more when you have a minute?
“There may be institutions that fail; far better to deal with them at the most basic level, that of the debtor, than trying to prop up dud institutions.”
I agree that we should let bankrupt institutions fail. Would like to know more (and understand the full implications of) about what you meant when you say we should deal with them “at the most basic level, that of the debtor”. Thanks!
“Rather, they did too much, and prolonged the depression more than it would have otherwise gone. Andrew Mellon was wiser than them all.”
Mr. Mellon presided over what still remains the most breathtaking economic collapse in our nation’s history. He was Treasury Secretary from 1921 to 1931, and it is said that his influence was such that 3 Presidents served under him. His party held majorities (usually commanding ones) throughout the period. When he left office, unemployment was at 15.9%, heading toward 23% and above before the 1932 elections. Yet, when the crash hit, he had the nerve to counsel that we “purge the rottenness out of the system.” He *ran* that rotten system, for over a decade. If you are advocating another helping of Andrew Mellon’s macroeconomic “wisdom,” I’ll pass. I do thank him for the National Gallery of Art, though.