Economics, Cycles & Politics

As I listened to this past Friday's dismal job growth numbers and persistent high unemployment, coupled with the prior Friday's dismal GDP growth numbers, it occurred to me that, due to the misleading mythology allowed to grow up around FDR's presidency, the US now seems destined to borrow and spend its way to ruin thanks to empirically discredited Keynesian economic policies.

Let's go back to basic macroeconomics. Before Keynes.

Economies move in cycles. If there were no presumption on the part of governments to attempt to repeal the laws of economic cycles, then we'd see what was prevalent in pre-1930s America and elsewhere. Expansions eventually slow as Samuelson's accelerator-multiplier  (see also here) theory kicks in,

"Stunningly simple, it seems to square, for me, at least, with human behavior. As many great economic insights do. Such as fellow Nobel Laureate Milton Friedman's concept of income as a steady, long-term expected value.



Samuelson noted that when growth slows from a higher rate, to a lower one, the mere slackening of growth is transmitted back through what we now would call the supply chain, as a series of demand reductions.


Instead of 10% more materials each year to make my products, this year, I need only 5% more.


My supplier will see a decrease in expected sales. Growth will be half of what it was, and, thus, sales fall below expectations.


While real output is still higher, the gradual cutback in production from expectations results in a contraction, as workers work to produce less. The cycle continues, and the multiplier effect, which, in forward gear, causes economic expansion, is responsible for its contraction when run in reverse.


Seen in this light, recessions which are attributable to simple changes in economic outlook can't really be affected very effectively by one-time fiscal monetary transfers."


Contraction follows expansion, then recession, followed by recovery and, subsequently, expansion.

Before America had the world's reserve currency, was the free world's economic hegemonist, and could basically print or borrow dollars at will, that's how most economies behaved.

Yes, you will now hear Keynesians decry over-savings, or the paradox of thrift, as ex-PIMCO managing director Paul McCulley did in a Bloomberg television interview on Friday afternoon. He now looks like some wild-haired ape-man, with an even more virulent streak of Keynesianism, now that he has no responsibility to PIMCO to appear the least bit economically sane.

But those arguments only appeared as Keynes wrote the General Theory and mistakenly believed that pump-priming, deficit spending, call it what you will, could actually and benevolently affect long term economic conditions positively.

We know now, decades later, that Keynes' theory was simply a sop to human desire for immediate gratification, while ignoring the very real longer-term consequences of debt, higher taxes, and reduced personal economic freedoms.

The linked post from last week, discussing the true nature of WWII as a time of immense savings and lowered consumption, setting the stage of the US economy's rapid growth in the 1950s, puts the lie to McCulley's contention regarding the so-called paradox of thrift.

The reality is that savings are collected and invested, eventually forming capital and underpinning healthy economic growth in the private sector, when natural economic forces are allowed to operate.

I believe that, much like the current mistaken belief by many that cutting social welfare programs like Social Security, Medicare, or Medicaid, constitutes a broken societal promise, the real question is whether the cure is worse than the disease.

Those social programs will never operate in a sustained fashion, designed, as they all were, with fatal flaws.

So, too, does Keynesian theory on government stimulus exist in a sort of fantasy world of arithmetic, rather than human, behavior. The reality is that the forced spending doesn't create lasting employment or economically-viable industries, but it leaves very real debt and a need for future spending reductions or increased taxes.

What was wrong with simply allowing natural economic cycles to operate in the first place, if the policies which economists have been able to develop as a method of repealing the laws of economic cycles bring side-effects which have ultimately proven worse than the original condition of naturally-occurring phases in economic cycles?

If the US federal government didn't have the monetary power of the world's reserve curency, combined with politicians of both parties who, once elected President, Senator, Representative or Fed Chairman, work furiously to retain those positions, do you really think we'd seriously be spending trillions of borrowed money to try to remove recessions and contractions from our economic cycles?

This folly has been primarly a politically-generated error. The health of the American economy doesn't require Keynesian stimulus spending- only the political careers of federal elected officials.

Subtle Political Bias On CNBC Yesterday Morning

Sometimes political bias seeps into business coverage so subtly that you don't really notice it at first.

This morning, on CNBC, this was on display front and center.

David Faber was co-anchoring with Becky Quick and Joe Kernen. Faber projects serious analytical credentials, which served to further blur what was about to take place. The guy he replaced for the morning has no such credentials, having apparently been selected to provide ethnic balance on the morning program.

Thus, when House GOP Majority Leader Eric Cantor appeared for an extensive discussion regarding the upcoming action on the nation's debt limit, the biased stage was set.

I won't give a blow by blow account of the discussion. You can probably correctly guess that Cantor defended the need to cut spending while raising the debt limit.

Faber, who leans politically fairly far left, judging by his on-air comments over a decade, chided Cantor for potentially creating a monetary disaster by causing the federal government to default on its debt.

For the record, despite what so many pundits, and Tim Geithner, allege, that's not the only outcome of a failure to raise the debt limit. The House can easily pass a bill to direct the Treasury to prioritize spending in order to pay interest, retire maturing debt, etc., so that internal spending is left unfunded.

What was so subtle, however, was how the network employed Faber to give a patina of credible analysis to what is largely a political topic.

Cantor gave as good as he got, being the intelligent and poised guy that he is. But what struck me as I listened was how, given Faber's line of attack, was his clear desire to put Cantor on the defensive, and completely ignore the excessive spending in Washington.

How differently another network could have handled the same appearance. Imagine a co-anchor asking Cantor if it were wise to pass the debt limit increase without any corresponding spending cuts to at least try to rein in federal fiscal excess?

The debate ran to issues like tax reform, on which Faber used the magic liberal phrase about wealthy people and corporations paying "their fair share." In this instance, Faber's analytical credibility was perhaps most misused, because his comments displayed a total misunderstanding of the difference between tax rates for and total taxes paid by various income strata. But, to hear Faber tell it, right along Democratic party lines, Cantor was espousing cutting spending on the poor, giving tax relief to the wealthy, while flirting with US government default.

Later, Texas Congressman Ron Paul made a guest appearance to discuss his announcement of an exploratory committee for a presidential candidacy, as well as his views on Bernanke's afternoon press conference.

In Paul's case, the subtle bias was to play a sort of video rope-a-dope. Paul is very serious and well-informed, being the current chair of the sub-committee of the House overseeing the Fed. When Paul lit into the Fed's opaqueness, failure to maintain the dollar's value, and a host of other mistakes, the co-anchors were largely mute. Nobody tried to debate Paul's allegations, nor make him out to be a wing nut. Instead, it was like Paul was declaiming into an empty room.

Sometimes I think CNBC is the anti-business network. This morning was a good example of it.

Wither The Euro?

I heard a quote attributed to Milton Friedman last week regarding the Euro.

Friedman allegedly predicted that the currency would collapse with its first financial crisis. After considerable reading, reflection and discussions with well-informed, learned colleagues, I find myself in agreement.

I wrote here recently that Doug Dachille crystallized for me some misgivings I've had since the beginning of the Euro. Dachille's viewpoint was echoed as I spoke with a very experienced retired CEO this past weekend.

With some added days' perspective since last week's continued turmoil over the Euro, and the prior week's ECB actions, it continues to be difficult to see how the Eurozone countries can grow their way out of this fiscal mess.

And it is a fiscal mess. Recall that the origin was a rather quiet disclosure months ago that the prior Greek government simply lied about its budgets and deficits.

I won't reiterate my and others' comments on the quasi-socialist, slow-growth economies of the EU, the transfer of wealth from Northern European nations to Southern ones, and the inevitable stress on fiscal policies, savings, taxes and long term Eurozone growth. It's enough to note that, once the immediate bailout/crisis mode has passed, the EU will continue to live with economic problems associated with funding the Greek and other national rescues.

The trouble may well bring down Angela Merkel's government in time. At that point, you have an opening for the previously unthinkable- German withdrawal from the Euro and its return to the DeutschMark.

Just because this won't all happen this next month or this summer doesn't mean pressure isn't building for a radical, discontinuous resolution of the simmering Euro problem. It's ultimately a cultural clash- robust, harder-working Northern European economies rescuing more spendthrift Southern European economies.

These nations have hundreds of years of experience as independent nations with independent fiscal policies. It's hard to believe they will move closer to surrendering those differing fiscal policies to a single, more powerful Brussels-based EU government. Thus, with the status quo probably untenable, the other extreme becomes more believable- the end of the Euro.

What We Haven't Learned From The Reagan Recovery

Yesterday's Wall Street Journal featured an editorial by economist Judy Shelton entitled "The Message of Dollar Disdain."

Quite by accident, since I had yet to turn to that page, I had a discussion with a business colleague over lunch about the same topic that Shelton mentioned at the end of her piece. I had told my friend about this recent post, based upon another Journal editorial, as well as a cross-post from my political blog featuring two video clips of Steve Wynn on fiscal policy. Both concerned the impact of proposed, costly social programs on a federal debt already bloated by roughly six decades of deficit spending.

Ms. Shelton wrote,

"Sadly, due to our fiscal quagmire, the Federal Reserve may be forced to raise interest rates as a sop to attract foreign capital even if it hurts our domestic economy. Unfortunately, that's the price of having already succumbed to symbiotic fiscal and monetary policy. If we could forge a genuine commitment to private-sector economic growth by reducing taxes, and at the same time significantly cut future spending, it might be possible to turn things around. Under President Reagan in the 1980s, Fed Chairman Paul Volcker slashed inflation and strengthened the dollar by dramatically tightening credit. Though it was a painful process, the economy ultimately boomed."

I mused to my friend about the same scenario. That is, I suggested that, if the long term effect of the weak dollar is, as David Malpass wrote in yet another Journal editorial, a fate much like Britain, the "hollowing out" of the US economy, then the solution is to raise interest rates on US Treasuries. Combined with more prudent fiscal policy, a la Wynn's observation that 'no government spending ever increased its country's standard of living,' in the form of restrained/reduced spending and lower taxes, genuine private economic activity would be resuscitated.

Such a move would, of course, sink various marginal business activity. But it would set off a chain reaction of virtuous consequences.

Banks would cut their lending to more viable projects which would clear hurdle rates of perhaps 3-5%, plus risk premium.

New capital would flow into the US to earn decent rates on fairly low-risk Treasuries.

That capital would flow to new business activity.

Money kept by taxpayers, instead of taken and spent by government, as well as not used to pay interest on higher deficits, would also seek investment returns, resulting in greater available capital for business activity.

As Ms. Shelton points out, this is precisely what occurred under the Reagan-Volcker regime.

The essential starting point is a commitment to the future, rather than the protection of past mistakes. In a word, an economy dedicated to Schumpeterian dynamics.

From this viewpoint, the mid-late Bush and certainly current administration's actions are exactly backwards. Rather than protecting existing, failed investments and propping up their value with taxpayer funds and borrowed capital from abroad, the more robust economic path would have been to let companies like GM, Chrysler, AIG, Goldman Sachs and Citigroup fail.

As Anna Schwartz noted in an interview she gave to the Journal last fall, on which I posted here. In that interview were the following passages,

"Ms. Schwartz won't say so, but this is the dirty little secret that led Secretary Paulson to shift from buying bank assets to recapitalizing them directly, as the Treasury did this week. But in doing so, he's shifted from trying to save the banking system to trying to save banks. These are not, Ms. Schwartz argues, the same thing. In fact, by keeping otherwise insolvent banks afloat, the Federal Reserve and the Treasury have actually prolonged the crisis. "They should not be recapitalizing firms that should be shut down.

But perhaps this is actually Mr. Bernanke's biggest problem. Today's crisis isn't a replay of the problem in the 1930s, but our central bankers have responded by using the tools they should have used then. They are fighting the last war. The result, she argues, has been failure. "I don't see that they've achieved what they should have been trying to achieve. So my verdict on this present Fed leadership is that they have not really done their job." "

Ms. Schwartz noted that liquidity was never the issue last fall, or even two years ago, when Helicopter Ben began reducing rates in a panic. Rather, she observed, the problem has been guessing which institutions were still actually solvent, as asset values spiraled downwards.

Monetary and fiscal policy which seek to protect past actions of private capital investors, at the expense of future ones, are doomed to stultify and cement an economy in the past.

Ms. Shelton's focus, while slightly different than that of Malpass or Lawrence Kadish, is never the less chilling. Whereas Malpass focused on exchange rate consequences, and Kadish on mounting interest and rates on the national debt, Shelton concentrated her analysis on the companion measure of US debt/GDP. On that measure, she notes, we will have vaulted, on the basis of current government estimates, from 23rd last year to 7th in 2011. The result? Ms. Shelton writes,

"The U.S. is thus slated to enter the ranks of those countries—Zimbabwe, Japan, Lebanon, Singapore, Jamaica, Italy—with the highest government debt-to-GDP ratio (which measures the debt burden against a nation's capacity to generate sufficient wealth to repay its creditors)."

Economic loss brings pain somewhere in an economy. Schumpeter's genius was to identify that this is the natural order of a healthy, growing capitalist economic system. Our policymakers cannot allow themselves to be unduly affected by the plight of those in the rearward areas of economic decay.

Transfer payments for employees of yesterday's now-faded economic titans is one thing. Actually rushing to preserve those enterprises with taxpayer funds is quite another. Or, worse, with borrowed funds from abroad.

When you assemble the views of the recent Journal economics editorialists- Malpass, Kadish and Shelton- you get a truly chilling picture of US monetary and fiscal policy gone mad.

Perhaps for the same reason so few of us seem to recall the economic horrors of the Carter years, for which Reagan's and Volcker's solutions were so effective, few also realize the danger we are in today.

Or that there is a fairly simple, if painful, way out now, as well.