June 22, 2012

We Are All Keynesians Now - at least According to National Review

Timothy Birdnow

The editors at National Review have gone mad.

Now that you have read the piece by Ramesh Ponnuru and former Bush Treasury economist David Beckworth you are invited, nay, stronly encouraged to close your mouth lest flies nest there.

I'm still picking them out of mine.

Yes, you read that right; NRO, the legacy of William F. Buckley, is advocating kickstarting inflation as the way to start the economy.

According to the article:

"The Fed’s initial response to the recession that began in 2007 and deepened in 2008 was to tighten money. It did so actively by paying banks interest on reserves at a rate higher than they could get from alternative safe investments such as U.S. Treasury securities. The banks, therefore, were incentivized to hold money instead of investing it. The Fed passively tightened by failing to offset the sharp drop in the total number of dollars being spent in the economy. When this number — called nominal spending — drops, it is because the demand to hold money increases or the supply of money decreases. By mid-2008 both forces were at work. Households and firms were holding more money and spending less at the same time financial firms were creating fewer assets that serve as money. When the number of dollars spent falls, so of course must the number of dollars made (nominal income). Either prices have to fall, the real economy has to shrink, or both. We got some of both. The Fed has not done nearly enough since then to correct its mistake."

End excerpt.

Or to put it in plain language, people stopped spending and started saving, and banks did likewise.

Banks wouldn't invest in T-bills because they were seen as bad investments. They were seen as bad investments because they didn't pay back well and, more importantly, Obama's spending spree made Treasury Bills appear too risky; who knows if the government would pay them back, or pay them back in worthless dollars?

That's the point that is ignored here; these "traditional investments" are dangerous in an inflationary period. Inflation traditionally helps the borrower, because he pays his loan back with money that is worth less than when he borrowed it. Deflation tightens credit because there are less dollars available, and it hurts the borrower who must pay his loan back not only with interest but with dollars that are worth more than those he borrowed. Banks earn less in an inflationary period but there is more money floating around. But lending to the government during an inflationary period is risky because the government may change the rules midstream and the lender has no recourse, and lending to the government is risky because there just isn't as much profit in it as during a period of stable currency. Ponnuru and Beckworth are arguing for precisely that.

And of course inflation eats away at the buying power of the citizenry, making the public cut back, which reduces economic activity over the long haul.

The reality is inflation is a tax, albeit a hidden one. National Review is calling for a tax increase on the American People, one that can be hidden in price increases. If the Reagan era taught us anything it is that reducing taxes and inflation stimulates economic activity, increasing revenues to the government. Ponnuru and Beckworth have fallen into the trap of thinking of inflation as something different than taxation.

I suppose Beckworth and Ponnuru do not remember the 1970's ended in a period of Stagflation, something the Keynesians said was impossible; stagnant economic growth and inflation. As things stand we are going to get inflation with Qualitative Easing expanding the money supply and with the explosion of government spending; that spending can only be paid for by expanding the money supply or raising taxes if you do not have robust economic growth, and there is no incentive to cut spending - something that our betters in Washington are unwilling to do anyway. So B and P think the answer is to print our way out of it ala Weimar Germany.

They won't put it that baldly; they argue for a 5% inflation of the currency. But they surely cannot be so foolish as to misunderstand that government is a chained dragon, and letting the beast off the chain means a dragon running wild. Nobody has found a way to stop inflation once started except through the most arduous of efforts (which can only come in a most painful fashion) and given the mountains of debt we are currently amassing that simply won't happen until the value of a dollar approaches absolute zero. I am not using excessive hyperbole here; it's happened before, in Weimar Germany, in Argentina, and elsewhere. Hyperinflation. How these brave Conservatives at the NRO could not understand this is beyond me.

The economy is not suffering from an excess in austerity, but from an overlarge government eating up too much of the assets and overregulating the private sector. It really is that simple. Inflation will simply let the government off the hook for spending, giving it more money to play with. There will be no effort to rein in spending, no effort to rein in regulation, no effort to reduce the size and scope of our out-of-control Leviathan.

Take a look at this chart. http://www.usgovernmentspending.com/federal_debt_chart.html

Gross Federal Deb Debt Held by Public
FY 2013* $17.5 trillion $10.6 trillion
FY 2012 $16.4 trillion $9.7 trillion
FY 2011 $14.8 trillion $8.5 trillion
FY 2010 $13.5 trillion $8.2 trillion
FY 2009 $11.9 trillion $6.8 trillion
FY 2008 $10.0 trillion $5.3 trillion

While the balance between private and public debt have not changed much the gross numbers have. Remember, a trillion dollars is a thousand BILLION. The entire U.S. economy is only equal to $188 Trillion dollars - that's everything - or 13.4 times GDP. So, we have crossed the entire Gross Domestic Product (roughly $14 trillion) in terms of what we owe http://rutledgecapital.com/2009/05/24/total-assets-of-the-us-economy-188-trillion-134xgdp/, and our debt is eating up that much of the economy. At best, government spending moves money from point a to point b without any multiplier effect, and actually it loses money as there are many sticky fingers between here and there. So, 6.4 trillion dollars have gone down the rabbit hole, becoming nonproductive.

What is forgotten here is that these numbers will skyrocket in a few years as the bill for excessive government spending comes due. Also, please note the 10.6 trillion dollar private debt; much of that private debt is there do to governmental policies (such as subprime mortgages) and there is a real chance it won't be paid back. Where does the money needed to keep the economy afloat come from if sizable portions of the private debt defaults? Government bailouts one debtor but at the expense of economic growth in general. Inflate the currency and everyone pays, the productive as well as the unproductive.

Yes, inflation can get us out of that trap, but at what cost? Inflation has DESTROYED countries in the past.

I am horrified to see this argument not on the pages of Time magazine or the New Republic but at National Review. This is every bit as bad as the Heritage Foundation's scheme in the '90's arguing for an individual mandate for health care.

The article makes the following point:

"It is once again time for regime change. The crisis in Europe and our stagnation at home both have primarily monetary causes, and a solution will require a new approach to monetary policy that learns from both the successes and the failures of the past."

If by monetary policy they mean chronic overspending, then I agree with them. But their argument for ending austerity measures belies the obvious here. The fact is that the crisis in Europe stems from an overly generous welfare state spending entirely too much money for entirely too long, and the crisis here at home could have been averted had WE not spent our way to the poor house. It is not a crisis of monetary policy but of political will. To paraphrase Dan Rather's comments on Ronald Reagan "we had a big party and now we have to pay for it". The housing bubble was driven by government money in the housing market, by over-regulation and demands by government that standards be lowered. It was draconian environmental standards imposed by government that wrecked the U.S. auto industry by preventing the development of new sources of oil and makng the automakers vulnerable, as well as CAFE standards, and this lead to the automaker's bailout. It was the "too big to fail" mantra that caused government money to bail out the banks rather than let bankruptcy take it's course. All of these things have led to market uncertainty and caution. Monetary policy has been part of the problem, but only part. Certainly inflated prices for oil damaged the car manufacturers, but that was a result of inflation - precisely what our dear friends at NRO are in favor of promoting.

It is also interesting to note that Ponnuru and Beckworth make the argument that ending the gold standard somehow ended the Great Depression. First, one must ask what is meant by a gold standard; there are different varieties. Britain moved from a gold species standard (where actual gold coins were in circulation) to a gold buillion stadard where gold acted as backing for base metal or paper money in 1925. One could argue that gold backing of currency rather than gold being currency made it subject to manipulation, which made Britain vulnerable to the crash and subsequent Depression. Britain ended the gold standard in 1931. Yes, the British economy improved, but that was inevitable given that Depressions rarely lasted more than six months prior to the Great Depression, and the recovery seen in Britain was not exactly miraculous. Ditto the other countries of Europe. What would have happened had the gold standard not been abandoned? We have no way of knowing, but perhaps the Depression would have actually ended and not smoldered on for another decade.

The point is, a true Conservative argues for an economy governed by Adam Smith's "hidden hand" and not by men. Men cannot see the resutls of their actions in a clear way, and often have motives that do not jibe with the health of said economy. The Conservative view is that the best medicine for an ailing economy is to get out of the way of recovery, which means reducing government spending and regulation. To argue for inflation is to argue for more government, because that is the ultimate end of currency manipulation, after all. Government is what caused this problem to begin with.

Government is empowered by money. Giving more to government is guaranteed to make it grow, and it is the growth of that government that has caused our current economic crisis.

It is sad to see so great an iconic institution as National Review fall so low. I suppose it's inevitable; the old guard ossifying and the new order sweeping in. But it still saddens me.

Perhaps Ponnuru and Beckworth should think about retiring; they have become part of the Establishment and hence part of the problem.

Posted by: Timothy Birdnow at 06:34 AM | No Comments | Add Comment
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