Friday, September 11, 2009

The Keynesians Were Wrong Again

We won't see a return to growth without incentives for job-creating investment.


From the beginning, our representatives in Washington have approached this economic downturn with old-fashioned, Keynesian economics. Keynesianism—named after the British economist John Maynard Keynes—is the theory that you fight an economic downturn by pumping money into the economy to "encourage demand" and "create jobs." The result of our recent Keynesian stimulus bills? The longest recession since World War II—21 months and counting—with no clear end in sight. Borrowing close to a trillion dollars out of the private economy to increase government spending by close to a trillion dollars does nothing to increase incentives for investment and entrepreneurship.
The record speaks for itself: In February 2008, President George W. Bush cut a deal with congressional Democrats to pass a $152 billion Keynesian stimulus bill based on countering the recession with increased deficits. The centerpiece was a tax rebate of up to $600 per person, which had no significant effect on economic incentives, as reductions in tax rates do.
Learning nothing from this Keynesian failure, which he vigorously supported from the U.S. Senate, President Barack Obama came back in February 2009 to support a $787 billion, purely Keynesian stimulus bill.
Even the tax-cut portion of that bill, which Mr. Obama is still wildly touting to the public, was purely Keynesian. The centerpiece was a $400-per-worker tax credit, which, again, has no significant effect on economic incentives. While Mr. Obama is proclaiming that this delivered on his campaign promise to cut taxes for 95% of Americans, the tax credit disappears after next year.
The Obama administration is claiming success, not because of recovery, but because of the slowdown in economic decline. Last month, just 216,000 jobs were lost, and the economy declined by only 1% in the second quarter. Based on his rhetoric, Mr. Obama expects credit for anyone who still has a job.
The fallacies of Keynesian economics were exposed decades ago by Friedrich Hayek and Milton Friedman. Keynesian thinking was then discredited in practice in the 1970s, when the Keynesians could neither explain nor cure the double-digit inflation, interest rates, and unemployment that resulted from their policies. Ronald Reagan's decision to dump Keynesianism in favor of supply-side policies—which emphasize incentives for investment—produced a 25-year economic boom. That boom ended as the Bush administration abandoned every component of Reaganomics one by one, culminating in Treasury Secretary Henry Paulson's throwback Keynesian stimulus in early 2008.
Mr. Obama showed up in early 2009 with the dismissive certitude that none of this history ever happened, and suddenly national economic policy was back in the 1930s. Instead of the change voters thought they were getting, Mr. Obama quintupled down on Mr. Bush's 2008 Keynesianism.
The result is the continuation of the economic policy disaster we have suffered since the end of 2007. Mr. Obama promised that his stimulus would prevent unemployment from climbing over 8%. It jumped to 9.7% last month. Some 14.9 million Americans are unemployed, another 9.1 million are stuck in part-time jobs and can't find full-time work, and another 2.3 million looked for work in the past year and never found it. That's a total of 26.3 million unemployed or underemployed, for a total jobless rate of 16.8%. Personal income is also down $427 billion from its peak in May 2008.
Rejecting Keynesianism in favor of fiscal restraint, France and Germany saw economic growth return in the second quarter this year. India, Brazil and even communist China are enjoying growth as well. Canada enjoyed job growth last month.
U.S. economic recovery and a permanent reduction in unemployment will only come from private, job-creating investment. Nothing in the Obama economic recovery program, or in the Bush 2008 program, helps with that.
Producing long-term economic growth will require a fundamental change in economic policies—lower, not higher, tax rates; reliable, low-cost energy supplies, not higher energy costs through cap and trade; and not unreliable alternative energy surviving only on costly taxpayer subsidies.
Unfortunately, Mr. Obama seems to be wedded to his political talking points, and his ideological blinders seem to be permanently affixed. So don't expect any policy changes. Expect an eventual return to 1970s-style economic results instead.
Mr. Ferrara, director of entitlement and budget policy for the Institute for Policy Innovation, served in the White House Office of Policy Development under President Reagan, and as associate deputy attorney general of the United States under the first President Bush.


Wednesday, September 9, 2009

Oh! What Might Haven Been...

Steve Forbes

The national focus is on health care, but soon we're going to have to face up to the oncoming entitlement train wreck. The Obama Administration is spending promiscuously even before it's done a lick of work to save Social Security, Medicare and Medicaid. There are positive pro-growth reforms that could preserve these programs for those already on them and those about to enroll, while at the same time instituting a new, stronger system for younger people. The Administration is oblivious to these ideas, but voters ultimately won't stand for being crushed by taxes and slashed benefits.
In the meantime, we can all ponder how different--and richer--our world would be had we enacted the Clark Amendment. In 1935 the Social Security issue dominated Congress, just as health care does today. The Roosevelt Administration was proposing a system in which workers would be taxed at a certain level, with employers matching that.
Even though Democrats overwhelmingly dominated Congress in 1935, there were deep misgivings about such a plan. Senator Bennett Champ Clark (D--Mo.) proposed an amendment to the pending Social Security bill. It would have allowed workers to go with the new government system or, if they wished, to have their money put into a private-insurance plan. Either way, the contributions would be mandatory. The idea of giving people such a choice proved to be extremely attractive. A majority of congressional Democrats were ready to vote for the Clark Amendment, but Franklin Roosevelt went ballistic, furiously denouncing the idea. He intensely disliked and distrusted the private sector, particularly life insurance companies. FDR lobbied hard to kill the Clark Amendment. Even so, the amendment almost passed.

FDR killed Senator Champ Clark's Social Security alternative. We'll need to resurrect it--and soon.
Imagine if the Clark Amendment had become part of the original Social Security Act. We wouldn't be saddled with today's fiscal disaster. Hundreds of billions of dollars that politicians have "borrowed" from the Social Security trust fund for all sorts of pork spending would not have disappeared. Instead, all that capital would have been invested in the economy, leaving us a lot more prosperous. Moreover, the Clark Amendment would have been a model for state pension plans, which are now bankrupting local governments, as well as for other nations.
The Clark Amendment incident is yet another example of how disastrous Franklin Roosevelt was for the U.S. economy, and an inspiration for reforming the system for younger people today.
Weak Dollar = Weak Revovery
A pernicious myth is at work among economists and policymakers, crippling a more vigorous economic recovery. It's the idea that a stable dollar means austerity and economic weakness. To get a stable greenback, the thinking goes, you have to withdraw cash from the banking system, so that dollars become scarcer and thus the remaining ones become more valuable. And doesn't having fewer dollars mean hurting the economy?
The opposite is true. Investing in plants, equipment and startups is risky enough. Add in the uncertainty over the value of the currency, and you get paralysis. Those with cash find it prudent just to sit on their hands and await developments or to speculate in commodities and currencies. A stable dollar would enormously help to break the investment logjam. It would also attract foreign capital--which our weak dollar currently repels. A volatile currency is the equivalent of a floating clock. Imagine how disruptive it would be if each day you didn't know how many minutes there were going to be in an hour?
How do you get a trustworthy currency? Not by starving or flooding the economy with liquidity. You don't get your car moving by flooding the engine with fuel nor do you get far by stalling it with insufficient fuel. You get the economy moving by giving it the liquidity it needs.
The most reliable fuel injector and gauge of liquidity is the ultimate four-letter word in government and central bank circles: gold. The intrinsic value of what John Maynard Keynes wrongly dubbed the barbarous relic doesn't change. All the gold that has been mined still exists; you can't consume it like corn or burn it like coal. It's rare but not too rare. Gold is a fixture. It's been the best guide for monetary policy because, like Polaris, which has been used to navigate by since time immemorial, it remains nearly stationary.

Global leaders had a grand time at April's G-20 Summit, while achieving nothing. The September confab won't be any different.
If Ben Bernanke, who has been given another turn as chairman of the Federal Reserve, would decisively declare that the Bush era's weak-dollar policy is over and that the Fed's monetary policy will henceforth be guided by commodities in general and gold in particular, the value of the dollar would soar--and without a single greenback having been withdrawn from circulation. The price of gold--and oil--would drop sharply. It's the fear of inflation that's keeping these commodities up.
Alas, Bernanke shows no grasp of the need for a strong currency. He doesn't understand that pumping liquidity into banks isn't the way to prevent economic hard times or stimulate better ones. He has ignored the example of Japan in the 1990s, when there was bank liquidity but little lending. Thus the paradox: Despite banks being loaded with almost record amounts of cash, bank lending has been down in recent weeks. Moreover, Bernanke promised early this year to revive the credit markets for small businesses and consumers, but the Federal Reserve has never taken action. He vowed the central bank would buy gobs of packages of such loans, but he never followed through. The critical securitization market for these kinds of loans remains largely dormant, which is the main reason that small businesses are still--and unnecessarily--suffering: Too many of them can't get credit.

We therefore have a situation in which a major cause of the lackluster recovery is being ignored. We are told that a dependable dollar must first await recovery, which is like saying we can't deal with mosquitoes until we first get rid of malaria.
In a few days leaders from countries representing 85% of the world economy will gather in Pittsburgh, Pa. for the G-20 Summit. There will be considerable backslapping and mutual self-congratulation that they have prevented Depression 2.0. There will also be a lot of pious palaver about the need for more cooperation, better international regulation and new initiatives to fight protectionism and promote free trade. Doing something effective and substantive, such as creating a modernized version of the gold-based Bretton Woods international monetary system--which lasted from the end of the Second World War until the early 1970s and gave us an era of great, noninflationary economic growth--will not even be broached. Had a Bretton Woods-type arrangement been in place during recent years, the current crisis would never have happened. The Fed simply would not have been able to print so much money and keep interest rates so low for so long.
If Bernanke can't get it right regarding the greenback, let's hope he at least takes the lead in beating back bank regulators and auditors who are still pressuring banks to curb lending and write down the value of existing and still good loans.
Prince of Enlightenment
America's premier political pundit and reporter, Robert Novak, died last month at age 78, after long bouts with cancer. He was a journalistic entrepreneur in a pantheon with the likes of Theodore White, whose The Making of the President books changed how presidential campaigns were covered. Novak's big breakthrough came in 1963, when he teamed up with Rowland Evans to write a syndicated column on politics for the New York Herald Tribune. (The Alsop brothers--Joseph and Stewart--had unsuccessfully tried such a venture years before, but they did their best work when they wrote individually.)
Evans and Novak had been distinguished reporters, but together they became the gold standard for information and analysis. This then-young political junkie was hooked on them from the get-go. Novak, especially, developed fantastic and voluminous sources and had the gift of seamlessly mining sources for additional and fascinating fodder.
Novak also broke ground on cable television, persuading CNN to let the two do a weekend show called, no surprise, Evans & Novak. Bob also begat two other CNN programs: The Capital Gang and Crossfire--and owned a piece of all three shows.
When I ran for the White House in the mid-1990s, appearing on Evans & Novak was an absolute must. As when you were a guest on Meet the Press, you prepped for an appearance before Evans and Novak as if you were facing a grueling oral doctoral exam.
Liberals called Novak the Prince of Darkness. Bob embraced the moniker and turned it into a marketing plus, using it as the title for his memoir, which has become something of a classic in the genre.

Robert Novak and Rowland Evans launching their legendary political column in the early 1960s.
Novak's mind never stood still. In the 1960s he was a moderate to liberal Republican. But by the late 1970s he had become a Reagan conservative. He was about the first noted national political reporter to actually understand supply-side economics, including monetary policy. As did Reagan, Novak grasped that a combination of sound money, low tax rates, restrained government spending and a strong military were the ingredients for a vibrant economy and a safer world.
One of the highlights of my life was two years ago, when Bob urged me to participate in the inaugural forum put on by the Academy on Capitalism & Limited Government Foundation, sponsored by the University of Illinois at Urbana-Champaign. An alumnus of the university, Novak was the principal speaker and moderator of the event. Immensely flattered, I accepted.
Bob's integrity was absolute--he was as hard on Republicans as he was on Democrats--and thankfully he possessed a skin of armor. When Novak was accused of "outing" the name of a CIA operative in a 2003 column, Democrats saw it as a way to hit the Bush Administration. They clamored for a special prosecutor, despite the First Amendment implications. (That this particular individual worked for the CIA was hardly a Beltway secret.) Novak's reputation survived like the Rock of Gibraltar. His source, Richard Armitage, was principal deputy to Secretary of State Colin Powell.
Bob--and, more important, the spirit in which he lived--will be much missed.

China Alarmed by U.S. Money Printing

The US Federal Reserve's policy of printing money to buy Treasury debt threatens to set off a serious decline of the dollar and compel China to redesign its foreign reserve policy, according to a top member of the Communist hierarchy.

By Ambrose Evans-Pritchard, in Cernobbio, Italy
Published: 9:06PM BST 06 Sep 2009

Cheng Siwei, former vice-chairman of the Standing Committee and now head of China's green energy drive, said Beijing was dismayed by the Fed's recourse to "credit easing".
"We hope there will be a change in monetary policy as soon as they have positive growth again," he said at the Ambrosetti Workshop, a policy gathering on Lake Como.
"If they keep printing money to buy bonds it will lead to inflation, and after a year or two the dollar will fall hard. Most of our foreign reserves are in US bonds and this is very difficult to change, so we will diversify incremental reserves into euros, yen, and other currencies," he said.
China's reserves are more than – $2 trillion, the world's largest.
"Gold is definitely an alternative, but when we buy, the price goes up. We have to do it carefully so as not to stimulate the markets," he added.
The comments suggest that China has become the driving force in the gold market and can be counted on to
buy whenever there is a price dip, putting a floor under any correction.
Mr Cheng said the Fed's loose monetary policy was stoking an unstable asset boom in China. "If we raise interest rates, we will be flooded with hot money. We have to wait for them. If they raise, we raise.
"Credit in China is too loose. We have a bubble in the housing market and in stocks so we have to be very careful, because this could fall down."
Mr Cheng said China had learned from the West that it is a mistake for central banks to target retail price inflation and take their eye off assets.
"This is where Greenspan went wrong from 2000 to 2004," he said. "He thought everything was alright because inflation was low, but assets absorbed the liquidity."
Mr Cheng said China had lost 20m jobs as a result of the crisis and advised the West not to over-estimate the role that his country can play in global recovery.
China's task is to switch from export dependency to internal consumption, but that requires a "change in the ideology of the Chinese people" to discourage excess saving. "This is very difficult".
Mr Cheng said the root cause of global imbalances is spending patterns in US (and UK) and China.
"The US spends tomorrow's money today," he said. "We Chinese spend today's money tomorrow. That's why we have this financial crisis."
Yet the consequences are not symmetric.
"He who goes borrowing, goes sorrowing," said Mr Cheng.
It was a quote from US founding father Benjamin Franklin.

Obama Gridlocked Is the Market’s New Best Friend

By Amity Shlaes

Sept. 8 (Bloomberg) -- Right wingers are in an uproar over President Barack Obama’s plan to address school children this week.
Some find such a display of sanctimony by a federal official toward school kids inappropriate.
Yet this use of the bully pulpit is probably good for a different crowd: bulls. Market bulls, that is.
Preaching like a social worker takes time away from other things the president might be doing, including finding enough votes to make his health-care overhaul truly radical. Over the weekend the story of the school speech actually overshadowed the speech the president is planning this week on health care.
Everyone knows that government in action can terrify markets. What matters most is the quality of the initiatives. There are those that change the world. And there is “feel good” activity that substitutes for significant change.
This latter kind is almost the equivalent of inactivity. A Washington abuzz over a pep talk for sulky sophomores is a Washington that might leave the rest of the economy alone to grow. The stock market recognizes this, and acts accordingly.
It all might provide an explanation for the past year. Last September both the White House and commentators argued that a financial bailout would save us. That such a bailout would help the market recover went without saying. The bailout package passed in early October, auguring involvement of the federal government in business of an unanticipated scale. Instead of rallying the Dow plunged below 10,000, and then below 9,000.
By October and early November, it was clear that Democrats would sweep into office, and that they were ready for action.
Worst Week
The week that the incoming team seemed most ferocious was the week of Nov. 17. Two things happened then. The first was that the president-elect’s new chief of staff, Rahm Emanuel, drove home his famous line, “you never want a serious crisis to go to waste.” Meanwhile news reports said that the president- elect and Senator John McCain, the defeated Republican challenger, had agreed to work together, a signal that Obama might have no opposition.
The combination represented the potential for more change by government than many adults could remember. Not good. The day it took in the Emanuel statement -- Nov. 19 -- the Dow Jones Industrial Average dropped more than 400 points.
Over the spring, though, it became clear that the Republicans weren’t going to support the Obama administration to the extent imagined in the fall. Even an all-Democratic Washington was confronting legislative limits. The market staged its rally.
Summer Rebound
This summer brought evidence that the president’s signature legislation on health care might not come as fast as anticipated, or might exclude the radical part, the public- insurance option. By July, the White House found it lacked the votes to pass the most dramatic version of health-care reform.
Senate Majority Leader Harry Reid then announced that the lawmakers wouldn’t be able to get a bill through before the August recess. The Dow jumped the 9,000 hurdle. Markets knew that lawmakers would be back at their desks come September, but they also believed now that Washington was capable of less than Emanuel had suggested.
The distinctions between different kinds of activity were first outlined by an economist at the University of Chicago, Frank H. Knight.
Knight drew a line between risk and uncertainty. Risk that can be quantified through theory or empirical work was one thing, he wrote: “insofar as the probability can be evaluated numerically by either method it can be eliminated and disregarded.”
Different Risks
Risks that can’t be measured are of a different type altogether. It is the unquantifiable uncertainty that interested Knight, who saw in it the possibility of profits for the bold few. But most of the rest of us just bury our heads in the sand.
Over time, theorists right, left and center have built on Knight’s work or come up with their own versions.
Former Treasury Secretary Robert Rubin, who is now chairman of the institution where I work, the Council on Foreign Relations, has long emphasized the value of forcing problems into frameworks of probability. In other words, shoving as much risk as possible into the easier, quantifiable category.
Rubin’s efforts and those of others in the Clinton administration reduced uncertainties and pleased markets: thus the 1990s rally. Former House Speaker Newt Gingrich’s decision to shut the government rather than agree to administration spending plans produced a gridlock that likewise precluded Emanuelesque action.
Possible Explanations
You can argue that government activism stoked the recent rally and that the so-called cash for clunkers consumer spree generated the summer’s rises.
Knightian Uncertainty, as it is known, is at least as plausible an explanation. Those trying to figure out how markets will move this fall might find cracking a copy of Frank Knight worthwhile.
I’ve written before about the Congressional Effect Fund, which buys and sells stocks on the premise that markets will rise when Congress is out of session -- that is, truly inactive.
But you get the drift: big new legislation -- bad. Government gridlock -- good. Speeches to school children -- outstanding.
(Amity Shlaes, author of “The Forgotten Man: A New History of the Great Depression” is a Bloomberg News columnist. The opinions expressed are her own.)