Is the Worst Yet To Come?
As the economic downturn moves into its third year, making it the longest in the postwar period, the White House announces yet another economic "stimulus" package. Now, this set of proposals is not to be confused with "Stimulus I" or "Stimulus II," or even the ongoing "stimulus" actions taken by Alan Greenspan and the Federal Reserve System. No, this proposal is based upon the same foolishness as the other legislative packages emanating from Washington that not only have brought about this recession, but also block the real recovery.
Moreover, the chatter by economists and other pundits over which is the proper "stimulus" action to take demonstrates that the Keynesian Revolution has been even more influential in the economics profession than the textbooks would have us believe. From Milton Friedman to Larry Kudlow to Paul Krugman to Maestro Greenspan himself, most economists can proudly repeat what President Richard Nixon uttered August 15, 1971, when he introduced "Phase I" of his disastrous economic program, "We are all Keynesians now."
The old joke that "if you take all the world's economists and lay them end to end, you'll never reach a decision" has been discredited, at least when it comes to proposing policy "solutions" to the moribund economy.
Actually, the belief that government can "stimulate aggregate demand" does not begin with Keynes, although there seem to be some economists who actually believe this. One can accurately say, I believe, that most of the economics profession has not progressed much beyond the 18th Century Mercantilists and their "inflation stimulates trade" nonsense that time and again has driven national economies to ruin.
While I suspect that most pundits actually would cheer the prospect of Kudlow and Krugman agreeing that the way to stop the economic mess is for the Fed to print wads of new money, the tragedy here is that neither man has even the slightest idea how this current downturn came about and what should be done. Should the government continue to listen to this newest generation of cranks in the tradition of Silvio Gesell (the Italian inflationist who Keynes called a "prophet"), we can expect to follow in the footsteps of Japan.
As has been written on this page many times, the 1990s boom—termed then as the "new economy"—was credit-driven and collapsed under its own weight of malinvested capital. Unfortunately, those with political power—and their allies in academe and the media—believe that our current problem is nothing more than a lapse in "aggregate demand," which can be cured by some new money and a few thousand government checks to be written for various wasteful federal and state projects.
While there seems to be no shortage of advice given from all quarters on how to stop this downturn, the answer is simple—and brutal: let the liquidation continue until it reflects the proper patterns of consumer spending and preferences. In other words, unless we permit an unhampered economy to engage in the very necessary adjustments, the economy will continue to slide further and further into ruin. Contrary to the beliefs of the chattering cranks, the U.S. economy is not depression proof.
While most Mises.org readers are aware of the massive U.S. recession of 1981–82, few remember that the Fed engaged in a much more responsible manner than what we have seen under Greenspan these past few years. First, and most important, the Fed permitted interest rates to soar to very high levels in response to the high rates of inflation that had plagued the U.S. economy for more than a decade.
While high interest rates temporarily choked off a number of credit-fueled industries like housing and farming, what is most important is that it permitted the massive malinvestments of the previous boom to be rapidly liquidated, thus allowing for a robust recovery. Although President Ronald Reagan won a huge landslide victory in the 1984 elections, few people remember that in 1982, as the recession raged on, most political experts had declared Reagan to be politically dead and there was open talk in Republican circles of someone else filling the GOP ticket for 1984.
Had the Reagan Administration—however unwittingly—not permitted the liquidation process to go on, it is doubtful that the economy would have experienced a strong recovery in 1983 and 1984. Unfortunately, the administration of George W. Bush does not see things that way, and the government has been desperately attempting to keep the needed economic liquidation from occurring. From the Fed's setting interest rates at near-zero levels to massive housing subsidies to steel and lumber tariffs to the latest re-emergence of huge farm subsidies, not to mention the saber rattling of the so-called war on terror, the Bush Administration has failed to permit the economy to settle back into its correct proportions.
While I applaud the president's attempts to cut the tax burden, his plans to increase government spending and pay for it with borrowed money makes his entire economic package a hollow one at best. Moreover, the Democrats seem to be taking their orders from Paul Krugman, who seems to believe that inflation plus a few checks from the already-bankrupt U.S. Treasury will cure nearly every economic ill.
The belief that our present economic downturn is nothing more than a lack of "aggregate demand" is simply wrongheaded on all counts. First, "aggregate demand" is in and of itself a fraudulent term. It assumes that all spending—and all investments and capital, for that matter—are homogeneous when they clearly are not. Furthermore, it is impossible to measure "aggregate demand," and even the way that it is shown (with the Consumer Price Level on the "y" axis) presupposes that inflation is the key to consumption. To put it another way, "aggregate demand" is, as economist Roger Garrison once put it, a way to try to teach macroeconomic principles "on the cheap" by trying to model the entire economy with single demand and supply curves.
Not only is the methodology of measuring "aggregate demand" terribly flawed, but the belief that simply encouraging "consumer spending" by placing more money in the hands of people through the "magic" of inflation is also ridiculous. Let me explain.
Cranks like Kudlow and Krugman write that if the government finds a way to quickly increase the incomes of individuals, then those folks are likely to spend a goodly portion, if not all, of the new money on items like a new car or television or some other set of goods. Inventories for those goods will be cleared at the "old" prices and people who sell those goods will have at least a temporary source of further employment. (Where they differ is that Kudlow believes in more across-the-board tax cuts, while Krugman wants only lower-income people to get the new money, since he believes they will be more likely to spend the money immediately.)
Even if the scenario painted by the cranks is true, there is nothing in their plan that will lead to economic growth. At best, items that had been languishing in warehouses and elsewhere will be sold, but that does not provide a signal to investors and business executives to engage in further investment of new capital—or even to keep current lines of production open.
For example, one of the demands made by Democrats is that any tax cut be temporary and limited to lower-income individuals. While I would welcome any reduction in taxes to anyone at any time, the idea that this plan would "stimulate" the economy is simply ridiculous. At best, it would permit existing inventories to be pared down, but that is about the extent of its "stimulus" qualities. Apparently, anything that might permit solid long-term possibilities of economic growth is anathema to the nation's policymakers of both parties.
Unfortunately for the political classes (and the rest of us who have to live with the political classes), the key to setting the table for economic recovery is to endure the liquidation without trying to interfere. Since any politician who "doesn't do anything" to stop the recession, either by intervening to keep firms in business or doling out government largess to those who lose their jobs, will come under heavy criticism, the prospects of non-intervention during this critical period are just about nil. Thus, the "compassionate" politicians are those who actually are doing the most damage to the economy.
During Bill Clinton's 1992 presidential campaign, his manager, James Carville, posted "It's the economy, stupid" signs throughout campaign headquarters and elsewhere. Perhaps we need a new slogan to fight the recession: It's the liquidation, stupid. While I doubt the motto will catch on with Bush and his political rivals, in the end, it really is the liquidation. Those who ignore this kernel of truth really are the stupid ones.