Stimulus & Resource Allocation- Part One

There has been much ink, electronic and chemical, spilled over the so-called stimulus package that passed Congress last week.

The horrifying details abound. So many pages that it would have been impossible for a member of Congress to read it completely and intelligibly in the forty eight hours available prior to the vote.

That our President, when campaigning, made all sorts of promises about having the legislation available on a website for five days for citizens to read and on which to comment. Never happened.

The same President, his advisers and cabinet nominees spent no time whatsoever authoring the bill. Rather, he tossed it to liberal House Democrats to write, making it, in effect, a bill with which the President had absolutely nothing to do, save stump for it in the poorest communities he could find.

I will bet you that he hasn't even read the bill himself, in full.

On my desk is a pile of recent Wall Street Journal articles predicting various sorts of doom that will follow from this latest Congressional and administration excess.

On February 2nd, Harold Cole and Lee Ohanian, both professors of economics, the latter known for his work at UCLA on this topic, wrote "How Government Prolonged the Depression." The title is self-explanatory. The details are captivating and scary.

On February 11th, Peter Ferrara, a policy development officer in Reagan's White House, wrote "Reaganomics vs. Obamanomics." Since Reaganomics actually worked, and led to two decades of fairly monotonic rises in GDP and incomes, with low inflation, this would seem to be a very important piece. It is. Ferrara notes that Reagan cut tax rates across the board, controlled government spending so that nondefense discretionary spending actually decreased, deregulated key industry sectors to boost productivity and production, while endorsing tight monetary policy.

Just the opposite of all four of these is now being planned and implemented.

On February 10th, Gary Becker and Kevin Murphy wrote "There's No Stimulus Free Lunch." Becker, an economic Nobel laureate, and Murphy, an economics professor at University of Chicago and a Hoover Institute fellow, explode a number of myths about the stimulus bill being spread by the administration and Congress.

One is Vice-Presidential economics adviser Jared Bernstein's falsehoods that the bill results in a "Keynesian multiplier effect" of 1.5. He and the administration's head of CEA, Christina Romer, allegedly modeled this effect, but they appear to be the only economists in America, with the likely exception of Paul Krugman, who believe it. Murphy and Becker explain why the true multiplier effect is more likely far below 1, but probably above zero.

The authors doubt that the torrent of spending can be controlled and/or shut off when the economy reaches full employment, meaning it will likely lead to significant inflation. They also question the efficacy of spending so much money in such a short period of time. In this, they are in agreement with Dick Armey and his harking back to Hayek in noting that Keynes never explained the mechanism whereby a government can make similar, economic-productivity seeking resource allocations that individuals and households make at the microeconomic level.

Finally, Becker and Murphy note that the longer run impact of taxes and interest on borrowed money, to pay for the stimulus bill, will substantially negate many of the results promised for the bill.

On February 6th, George Melloan wrote an informed piece reviewing the global effects of Treasury borrowing to pay for this stimulus bill. He writes, ominously,

"Even when the economy and the securities markets are sluggish, the Fed's financing of big federal deficits can be inflationary. We learned that in the late 1970's, when the Fed's deficit financing sent the CPI up to an annual rate of almost 15%. That confounded Keynesian theorists who believed then, as now, that federal spending "stimulus" would restore economic health.

Inflation is the product of the demand for money as well as of the supply. And if the Fed finances federal deficits in a moribund economy, it can create more money than the economy can use. The result is "stagflation," a term coined to describe the 1970s experience. As the global economy slows and Congress relies more on the Fed to finance a huge deficit, there is a very real danger of a return to stagflation. I wonder why no one in Congress or the Obama administration has thought of that as a potential consequence of their stimulus package."

I think Melloan is being conservative in his use of the adjective "potential" in his last sentence. There's nothing potential about what is going to happen as a result of this gigantic pork barrel bill.

Then we come to Journal columnist Daniel Henninger's "Exactly How Does Stimulus Work?," on February 12th.

Henninger pokes fun at the President's reference, in Elkhart, Indiana, to the Keynesian multiplier, calling the weatherization of homes,

"an example of where you get a multiplier effect."

Does anyone believe the President could define or give an example of what a Keynesian multipier effect is, and how it works?

I can, having taken a boatload of economics courses in my past, and continued to remain abreast of macroeconomics since business school. I have actually read Keynes' "General Theory."

What troubles me now is a sort of denial of our economic experiences of the 1930s on a par with those who, for example, deny that the Holocaust ever occurred.

Surely, if Congress and our President publicly stated that the Holocaust never happened, they'd be the subject of outrage, anger, and calls for retraction of their statements.

But their assertion that FDR's "stimulus" worked is the economic equivalent of claiming that the Holocaust was imaginary. Both are demonstrably false statements.

In the years since my entry into the work force, I have seen at least two crucial developments in global financial markets which would have brought FDR's stimulus program to a grinding, failed halt much sooner than it did.

One, of course, is linked, floating exchange rates. No Treasury Secretary or Finance Minister was ever so disciplined as those who have served after the end of fixed exchange rates. Inflation and interest rates bite much harder and faster now that they cannot be so disguised or manipulated by governments.

The other is global liquidity of private capital at the speed of electrons. Again, government finance officers now must contend with immediate votes on their fiscal and monetary policies by hundreds of billions of dollars of fast-moving private capital.

That's why American equity markets plunged some 5% upon the passage of the stimulus bill and Tim Geithner's ineffectual stumbling over his ever-planned, never-revealed financial sector "plan."

What is missing from Congress' and the administration's calculations is a common sense notion of how one can really effect immediate spending on what our society believes are the most important projects, from an economic and productivity perspective.

I will address that point in part two of this post.