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U.S. Economic Recovery Remains Anemic, at Best

How goes the recovery? Not well, it seems. Indeed, according to the most recent official estimates, it is anemic, at best.

As the chart shows, real GDP has recovered its losses during the recent contraction and is now running at about the same rate as it was at its pre-recession peak in late 2007. So, the rate at which the U.S. economy produces total output has gained nothing during the past four years, and its present rate of growth, even if it continues, is too slow to bring back into employment many of the would-be workers now without work, including a disturbing number who have been without employment for years.

As I have discussed previously, consumption spending has recovered fully, and government spending has reached new highs. Investment spending, however, remains depressed despite some recent pickup. Real gross private domestic investment has increased from its recession trough of about $1.4 trillion per annum to a current annual rate of about $1.8 trillion, as the chart shows. However, it remains far below its prerecession peak of almost $2.3 trillion. Moreover, about $1.5 trillion of the current gross spending rate does nothing but compensate for depreciation—obsolescence and wear-and-tear—of the current capital stock, leaving only about $0.3 trillion per annum as real net private domestic investment.

We all understand, of course, that the housing boom and bust have left the country with a great deal of residential housing that cannot be sold without much greater reductions in the already-greatly-reduced asking prices. Therefore, little incentive exists for new investment in residential housing, and so this type of investment is currently running at only about 40 percent of its pre-recession peak rate, as the chart shows, and it has shown no substantial sign whatever of recovery.

However, the residential housing bust is scarcely the whole story of the presently depressed investment spending. As the chart shows, real private nonresidential fixed investment (a much larger component of total investment, even during the housing boom), despite rapid recovery from its recent trough in late 2009, remains well below—about 7 percent below—its prerecession peak rate.

The rate of unemployment of labor (U-3) has remained stuck in the 9-10 percent range for roughly two and a half years. Given the difficulties of interpretation associated with the labor department’s measures of unemployment, we can see with more assurance what has been happening in the labor market by looking instead at employment. Here we see, as the chart shows, that although almost 3 million persons have been added to the employment rolls during the past two years, approximately six million fewer persons are employed in private industries now than were employed at the prerecession peak. Moreover, fewer persons are privately employed now than were employed in 2000—eleven years ago, when the population was substantially smaller.

In sum, although we see some indications that recovery has occurred, the labor market remains far from a full recovery, as does the volume of net private investment. The former is unlikely to recover fully until the latter begins to grow rapidly. However, given the present clouded prospects for the security of investors’ private property rights, with regime uncertainty hovering over public policy in many critical regards, the likelihood of a strong investment boom must be considered extremely slight.

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Posted on: Sunday, November 6, 2011 - 21:22

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The Inversion of America's Dominant Ideology

According to an ABC News report last week,

At a million-dollar San Francisco fundraiser today [October 26], President Obama warned his recession-battered supporters that if he loses the 2012 election it could herald a new, painful era of self-reliance in America.
“The one thing that we absolutely know for sure is that if we don’t work even harder than we did in 2008, then we’re going to have a government that tells the American people, ‘you are on your own,’” Obama told a crowd of 200 donors over lunch at the W Hotel.
“If you get sick, you’re on your own. If you can’t afford college, you’re on your own. If you don’t like that some corporation is polluting your air or the air that your child breathes, then you’re on your own,” he said. “That’s not the America I believe in. It’s not the America you believe in.”

How horrible the prospect! On your own to pay for your own health care; on your own to pay for your own college expenses; on your own to pay for a lawsuit against a corporation that has harmed you unlawfully. How can anyone with an ounce of humanity in his body expect people to take such self-responsibility? The next thing you know, those callous, reactionary Republicans—you know, the ones who ran up the size, scope, and power of government consistently under every Republican president since Chester Arthur—will demand that people take care of their own children and aged parents! Where will it end?

To gauge the extent to which the dominant ideology of the United States has changed—indeed, turned upside down—during the past century or so, we need only recall one of Grover Cleveland’s most characteristic declarations, made in his veto of the Texas Seed Bill, a trifling appropriation of $10,000 to help drought-striken farmers in 1887:

I can find no warrant for such an appropriation in the Constitution, and I do not believe that the power and duty of the general government ought to be extended to the relief of individual suffering which is in no manner properly related to the public service or benefit. A prevalent tendency to disregard the limited mission of this power and duty should, I think, be steadfastly resisted, to the end that the lesson should be constantly enforced that, though the people support the government, the government should not support the people.
The friendliness and charity of our countrymen can always be relied upon to relieve their fellow-citizens in misfortune. This has been repeatedly and quite lately demonstrated. Federal aid in such cases encourages the expectation of paternal care on the part of the government and weakens the sturdiness of our national character, while it prevents the indulgence among our people of that kindly sentiment and conduct which strengthens the bonds of a common brotherhood.

Later, in his second inaugural speech, in 1893, Cleveland reiterated this traditional American stance in favor of limited government, personal self-reliance, and private charity:

The verdict of our voters which condemned the injustice of maintaining protection for protection’s sake enjoins upon the people’s servants the duty of exposing and destroying the brood of kindred evils which are the unwholesome progeny of paternalism. This is the bane of republican institutions and the constant peril of our government by the people. It degrades to the purposes of wily craft the plan of rule our fathers established and bequeathed to us as an object of our love and veneration. It perverts the patriotic sentiments of our countrymen and tempts them to pitiful calculation of the sordid gain to be derived from their Government’s maintenance. It undermines the self-reliance of our people and substitutes in its place dependence upon governmental favoritism. It stifles the spirit of true Americanism and stupefies every ennobling trait of American citizenship.
The lessons of paternalism ought to be unlearned and the better lesson taught that while the people should patriotically and cheerfully support their Government its functions do not include the support of the people.

No politician seriously seeking the presidency today would dare to say what Cleveland—an exceptionally courageous and honest politician even in his day—said in the late nineteenth century. American politcos have learned that the people have come to crave government paternalism, indeed, that they pant for it and demand it at every turn. Obama is not the brightest light, yet he understands how to get elected, and in that quest he is pandering to the same personal irresponsibility and desire to prey on one’s fellows that have been the hallmarks American politics from the Progressive Era to the present.

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Posted on: Sunday, October 30, 2011 - 15:31

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The Euthanasia of the Saver

In chapter 24 of The General Theory of Employment, Interest and Money, John Maynard Keynes laid out his screwball idea that capital might soon become, or be made to become, no longer scarce; hence no payment would have to be made to induce people to save, and that condition would be splendid inasmuch as it would entail the “euthanasia of the rentier.” This stuff really must be seen to be believed; here is the meat of Keynes’s discussion in his own words:

The justification for a moderately high rate of interest has been found hitherto in the necessity of providing a sufficient inducement to save. But we have shown that the extent of effective saving is necessarily determined by the scale of investment and that the scale of investment is promoted by a low rate of interest, provided that we do not attempt to stimulate it in this way beyond the point which corresponds to full employment. Thus it is to our best advantage to reduce the rate of interest to that point relatively to the schedule of the marginal efficiency of capital at which there is full employment.
There can be no doubt that this criterion will lead to a much lower rate of interest than has ruled hitherto; and, so far as one can guess at the schedules of the marginal efficiency of capital corresponding to increasing amounts of capital, the rate of interest is likely to fall steadily, if it should be practicable to maintain conditions of more or less continuous full employment—unless, indeed, there is an excessive change in the aggregate propensity to consume (including the State).
I feel sure that the demand for capital is strictly limited in the sense that it would not be difficult to increase the stock of capital up to a point where its marginal efficiency had fallen to a very low figure. This would not mean that the use of capital instruments would cost almost nothing, but only that the return from them would have to cover little more than their exhaustion by wastage and obsolescence together with some margin to cover risk and the exercise of skill and judgment. In short, the aggregate return from durable goods in the course of their life would, as in the case of short-lived goods, just cover their labour costs of production plus an allowance for risk and the costs of skill and supervision.
Now, though this state of affairs would be quite compatible with some measure of individualism, yet it would mean the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital. Interest today rewards no genuine sacrifice, any more than does the rent of land. The owner of capital can obtain interest because capital is scarce, just as the owner of land can obtain rent because land is scarce. But whilst there may be intrinsic reasons for the scarcity of land, there are no intrinsic reasons for the scarcity of capital. An intrinsic reason for such scarcity, in the sense of a genuine sacrifice which could only be called forth by the offer of a reward in the shape of interest, would not exist, in the long run, except in the event of the individual propensity to consume proving to be of such a character that net saving in conditions of full employment comes to an end before capital has become sufficiently abundant. But even so, it will still be possible for communal saving through the agency of the State to be maintained at a level which will allow the growth of capital up to the point where it ceases to be scarce.
I see, therefore, the rentier aspect of capitalism as a transitional phase which will disappear when it has done its work. And with the disappearance of its rentier aspect much else in it besides will suffer a sea-change. It will be, moreover, a great advantage of the order of events which I am advocating, that the euthanasia of the rentier, of the functionless investor, will be nothing sudden, merely a gradual but prolonged continuance of what we have seen recently in Great Britain, and will need no revolution. [pp. 375-76]

Given the Fed’s policy during the past three years of, first, driving short-term interest rates down almost to zero, and, more recently, undertaking Operation Twist, with the intent of driving longer-term interest rates down to levels that, in real terms, equal or fall below zero, we might seriously wonder whether Chairman Ben Bernanke and his colleagues have decided to give a shove to the wheel of history that Keynes longingly anticipated.

However that may be, no one can dispute that people who rely on the earnings on invested funds to support themselves—a situation in which many retired persons in particular find themselves—are now in a world of hurt. Bank savings accounts are paying interest rates of 1 percent or less. Certificates of deposit are paying 0.5 percent to 1.7 percent, depending on the term. U.S. Treasury bonds with terms of 5 to 30 years are yielding in the neighborhood of 1 percent to 3 percent.

In short, the highest yield available to ordinary investors who seek a simple, low-risk investment of their funds is, at best, roughly equal to the rate of inflation—and then, with a 30-year term to maturity, only with substantial risk of capital loss if interest rates should rise. To put the matter another way, all ordinary investors are now being progressively impoverished because the nominal return on their investments falls short of the loss of purchasing power of the dollar during the term of the investment. Getting a positive real rate of return is effectively impossible for the proverbial widows and orphans. Only investors with the knowledge of how to invest in gold, crude commodities, and other such esoteric assets stand any chance of earning positive real returns, and then only with great risk of substantial capital losses.

Given that the Fed’s official policy is to drive all interest rates to near zero, one may conclude that the Fed seeks to impoverish the widows, orphans, retired people, and all other financially untutored people who rely on interest earnings to support themselves in their old age or adversity. Can a crueller official policy be imagined, short of grinding up these unfortunate souls to make pet food or fertilizer?

The politicians constantly bark about their solicitude for those who are helpless and in difficulty through no fault of their own. Yet, the scores of millions of people who saved money to support themselves in old age now find themselves progressively robbed by the very officials who purport to be their protectors. There are many reasons to oppose the Fed’s policy. The reason brought to mind by the official enthanasia of the nation’s small savers deserves far more attention than it has received to date.

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Posted on: Saturday, October 29, 2011 - 16:26

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Important New Evidence on Regime Uncertainity

When I introduced the concept of regime uncertainty in 1997, attempting to improve our understanding of the Great Depression’s extraordinary duration, I anticipated that many people—especially my fellow economists—would not welcome this contribution. Their primary objection, I ventured, would be that the concept remained too vague and, most of all, that it had not been reduced to a quantitative index of the sort that modern mainstream economists customarily work with, especially in their empirical macroeconomic analyses.

My argument did not lack evidence, however, and I regarded the agreement of several different forms of evidence as an important element of the argument’s force. The evidence I adduced with regard to changes in the yield spreads for high-grade corporate bonds of differing maturities seemed to me both systematic and especially compelling, though not decisive because alternative explanations of those changes might be offered. (I considered several such explanations and rejected them as unpersuasive in one way or another.) Recently, in my application of the concept of regime uncertainty to help us understand better the persistent economic troubles since 2007, I again advanced several different kinds of evidence, including as before an analysis of changes in the yield curves for high-grade corporate bonds. This time, too, the evidence is consistent with the underlying argument.

Nevertheless, the argument scarcely gained widespread assent, and most analysts either ignored it completely or, like Paul Krugman, dismissed it as a fairy tale—in his view, the sort of wholly fictitious notion that would be peddled only by think-tank whores in the pay of Republican plutocrats. (I trust that everyone who knows me will see how closely I fit this template.)

Now, however, more respectable analysts than I have accepted the challenge of showing that regime uncertainty can be measured systematically and that the resulting index “shows U.S. policy uncertainty [is currently] at historically high levels.” This research has been been carried out by three analysts at two of the world’s preeminent research universities: Scott R. Baker and Nicholas Bloom at Stanford University and Steven J. Davis at the University of Chicago. I highly recommend that anyone interested in this matter read the October 5 summary of these analysts’ research published online by Bloomberg News.

Some highlights:

• A major factor behind the weak recovery and gloomy outlook is a climate of policy-induced economic uncertainty. An index we devised . . . shows U.S. policy uncertainty at historically high levels.

• We constructed our index by combining three types of information: the frequency of newspaper articles that refer to economic uncertainty and the role of policy, the number of federal tax code provisions set to expire in coming years, and the extent of disagreement among forecasters about future inflation and government spending.

• Our index shows prominent surges in policy uncertainty around the time of major elections, the outbreak of wars and after the Sept. 11 attacks. It shows another surge after the bankruptcy of Lehman Brothers Holding Inc. in September 2008. Policy uncertainty has remained at high levels ever since.

• [T]he data refute the view that economic uncertainty necessarily breeds policy uncertainty. In the last decade, however, policy became a larger source of movements in overall economic uncertainty and an increasingly important concern for businesses and households. . . . [T]he persistence of policy uncertainty . . . reflects deliberate policy decisions, harmful rhetorical attacks on business and “millionaires,” failure to tackle entitlement reforms and fiscal imbalances, and political brinkmanship.

• To identify the drivers of policy uncertainty, we drilled into the Google News listings and quantified the factors at work. Several factors account for the high levels of policy uncertainty in 2010 and 2011, but monetary and tax issues predominate. Uncertainties related to health-care policy, labor regulations, national security and sovereign-debt concerns play contributing roles.

• Negative economic effects of uncertainty operate through multiple, reinforcing channels. When households are fearful about job loss, wages, taxes and retirement funds, they cut back on expenditures. The drop in consumer spending means weak sales for businesses and lower sales-tax collections for governments.

• When businesses are uncertain about taxes, health-care costs and regulatory initiatives, they adopt a cautious stance. Because it is costly to make a hiring or investment mistake, many companies will wait for calmer times to expand. If too many businesses wait, the recovery never takes off. Weak investments in capital goods, product development and worker training also undermine longer-run growth.

• So how much near-term improvement could we gain from a stable, certainty-enhancing policy regime? We estimate that restoring 2006 levels of policy uncertainty would yield an additional 2.5 million jobs over 18 months. Not a full solution to the jobs shortfall, but a big step in the right direction.

See the authors’ report for more detail.

The index constructed and analyzed by Baker, Bloom, and Davis, like any such index, may be faulted in various ways. Working with such data and the indexes constructed from them is a never-ending task of correction and refinement for empirical researchers. Nevertheless, these analysts have met the challenge of producing a systematically measured quantitative index of regime uncertainty (they call it policy uncertainty) over a long period, and they have presented reasonable arguments that tie the index’s movements to specific policy measures and future possibilities. Their evidence certainly deserves as much respect as the standard National Income and Product Accounts (NIPA) estimates prepared by the Commerce Department’s Bureau of Economic Analysis, much of which derives from highly questionable definitions and assumptions and from underlying data subject to a variety of errors—yet economists swallow the NIPA estimates all the time without choking.

The idea of regime uncertainty had sound economic theory and substantial empirical evidence to support it from the beginning, and a great deal of additional evidence has accumulated over the past three years. Yet critics have continued to dismiss it either as Republican bunk bought and paid for by Obama-hating billionaires or as a sort of “just so” story concocted by flaky think-tank nobodies, such as yours truly. Now, however, the research reported by Baker, Bloom, and Davis knocks the ball firmly back into the critics’ court. Don’t be surprised if they take a whack at it. Whether their attempt will succed intellectually is another matter.

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Posted on: Saturday, October 8, 2011 - 14:43

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Influential Financial Economist Turns to Austrianism

Thomas Mayer is the chief economist of Deutsche Bank Group and head of Deutsche Bank Research. He has an impressive background as a highly placed analyst in major private and public financial institutions. Which is to say, when he speaks, people are much more likely to pay attention and to give weight to what he says than they are when those of us on the lunatic fringe spout off.

So, it is an event of considerable note that Mayer has recently given a speech in which he roundly condemns the major macroeconomic theories embraced since the 1930s and the government policies that have flowed from them. He holds these theories and policies responsible for creating false understandings of how the economy works and of what governments can and should do in their efforts to manage the economy and, in particular, to stabilize its growth path.

Mayer urges a turn away from economists’ attempts to ape natural scientists and a renewed appreciation of the lessons of economic history. “A revival of Austrian economics,” he concludes, “could be a good start for such a research program.” I certainly applaud this advice. Unfortunately, Mayer’s understanding of Austrian economics in general—and its theory of macroeconomic booms and busts, in particular—is somewhat defective. Nevertheless, he gets part of it right, and he is undoubtedly moving in the right direction.

Here are the bullet points that introduce his article:

• Failure of the “liquidations” to overcome the Great Depression of the early 1930s prepared the ground for an era of interventionist economic policies. Modern macroeconomics and finance nourished the belief that we can successfully plan for the future. But the present crisis teaches us that we live in a world of Knightian uncertainty, where the “unknown unknowns” dominate and our plans for the future are regularly thwarted by unforeseen and unforeseeable events.

• In a world of Knightian uncertainty, financial firms and investors need larger buffers to cope with the unforeseen, i.e., more equity and less leverage.

• In a world where markets are not always liquid but can seize up in a collective fit of panic, financial firms and investors also need a greater reserve of liquidity.

• Regulation can help to achieve both objectives, but it needs to realize its limits. First and foremost, firms should have the incentives to follow sound business practices. The best incentive is to make failure possible. Hence, we need resolution regimes for financial firms.

• In a world where people have imperfect foresight and do not always behave rationally, and markets are not always efficient, we need to accept that economic policy cannot fine-tune the cycle.

• For us economists, the lesson from recent events should be to rely less on the development of theories by “deduction” (like in natural sciences) and to apply more “induction” (like in social and historical sciences). Failure to study history makes us repeat the mistakes of the past.

Despite my reservations in a few regards, I find Mayer’s views in this speech to be on target for the most part, and I highly recommend it. In several regards, his presentation complements a recent article of mine in which I criticize major elements of currently received wisdom in macroeconomics—what I call “vulgar Keynesianism.”

(I am grateful to Ángel Martín Oro for bringing Mayer’s speech to my attention; see his article [in Spanish] with José Abad at LibreMercado.)

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Posted on: Sunday, September 18, 2011 - 18:56

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One More Time: Consumption Spending HAS Already Recovered

Commentators and pundits, some of whom ought to know better, continue to harp on the idea that the recession persists because consumers are not spending. Every Keynesian seems to believe that because consumers are in a dreadful funk, only government stimulus spending can rescue the moribund economy, given (to them, at least) that investors will not spend more because the Fed, having already driven interest rates to extraordinarily low levels, cannot use conventional policies to drive them any lower and thereby elicit more investment spending.

People, please look at the data. They are conveniently available to one and all at the website maintained by the Commerce Department’s Bureau of Economic Analysis, the outfit that generates the national income and product accounts for the United States.

According to these data, real personal consumption expenditure recovered from its recession decline by the fourth quarter of 2010. Continuing to grow, it now stands (as of the most recent data, for the second quarter of 2011) even farther above its pre-recession peak.

Real government expenditure for consumption and investment (this concept does not include the government’s transfer spending, such as unemployment insurance benefits and social security benefits) is also running higher than its pre-recession level. In the second quarter of 2011, it was running more than 2 percent higher (recall that this is “real,” or inflation-adjusted spending; nominal spending has grown substantially more).

The economy remains moribund not because consumption spending has failed to recover and not because government spending has failed to increase, but because the true driver of economic growth—private investment—remains deeply depressed. Gross private domestic fixed investment fell steeply after the second quarter of 2007, and in the second quarter of 2011 it remained 19 percent below its pre-recession peak. This figure fails to show how bad the investment situation really is, however, because the bulk of the investment spending now taking place is for what the accountants call the ”capital consumption allowance,” the amount estimated as necessary to compensate for the wear and tear and obsolescence of the existing capital stock.

The key variable is net private domestic fixed investment—the investment that builds the productive private capital stock. Quarterly data through this year are not currently available at the BEA website, but the annual data show that an index of its real amount peaked in 2006, fell substantially in each of the following three years, and recovered only slightly in 2010, when the index showed net private domestic fixed investment was running about 78 percent below its level in 2005 and 2006. Here is the true reason for the recession’s persistence.

Private investors, despite the full recovery of real consumer spending and the increase of real government spending for final goods and services, remain apprehensive about the future of new investments, especially new long-term investments. I have argued repeatedly during the past three years that an important reason for this apprehension and the consequent reluctance to make new capital commitments is regime uncertainty—in this case, a widespread, serious fear that the government’s major policies in areas such as taxation, Obamacare, financial reform, environmental regulation, and other areas will have the effect of depriving investors of control over their capital or diminishing their ability to appropriate the income that the capital generates. President Obama’s harping on the desirability of making “the rich” pay their “fair share” (that is, more) of the government’s ever-rising costs only exacerbates regime uncertainty. Business leaders have spoken again and again of how the present political environment is discouraging risk-taking and entrepreneurship.

In any event, it should be crystal clear that the problem is not the failure of consumer spending to recover. Let us please have more respect for the facts than to continue singing that old, thoroughly worn-out tune.

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Posted on: Friday, September 9, 2011 - 16:00

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Regime Uncertainty: Pirrong Debunks the Keynesian Debunking

As the idea of regime uncertainty has gained ground in recent years as a partial explanation of the economy’s failure to recover quickly and fully, economists and others invested in Keynesian thinking have begun to strike back. One such Keynesian debunking of regime uncertainty was offered recently by Gary Burtless and seemingly endorsed by Mark Thoma. Now, Craig Pirrong, an economist at the University of Houston, has debunked Burtless’s arguments.

Pirrong uses options pricing theory to show why the Keynesians are missing the point of the regime uncertainty concept and why, even on their own terms, their arguments for disregarding regime uncertainty and simply pumping up aggregate demand are wrong.

To adapt a familiar saying: first they ignore you, then they ridicule you, then they embrace the idea and claim that they had it first. We are now passing through Stage II.

Although I am pleased that the concept of regime uncertainty has come to be recognized in some quarters as an important part of our understanding the economy’s operation, I continue to be disconcerted that many of those who speak of it, including some of those who speak favorably of it, fail to understand its full scope. As I understand regime uncertainty, it has to do with widespread inability to form confident expectations about future private property rights in all of their dimensions. Private property rights specify the property owner’s rights to decide how property will be used, to accrue income from its uses, and to transfer these rights to others in various voluntary arrangements. Because the content of private property rights is complex, threats to such rights can arise from many different sources, including actions by legislators, administrators, prosecutors, judges, juries, and others (e.g., sit-down strikers, mobs).

Because of the great variety of ways in which government officials can threaten private property rights, the security of such rights turns not only on law “on the books,” but also to an important degree on the character of the government officials who administer and enforce the law. An important reason why regime uncertainty arose in the latter half of the 1930s, for example, had to do with the character of the advisers who had the greatest access to President Franklin Roosevelt at that time—people such as Tom Corcoran, Ben Cohen, William O. Douglas, Felix Frankfurter, and others of their ilk. These people were known to hate businessmen and the private enterprise system; they believed in strict, pervasive regulation of the market system by—who would have guessed?—people such as themselves. So, as bad as the National Labor Relations Board was on paper, it was immensely worse (for employers) in practice. And so forth, across the full range of new regulatory powers created by New Deal legislation. In a similar way, the apparatchiki who run the federal regulatory leviathan today can only inspire apprehension on the part of investors and business executives. President Obama’s cadre of crony capitalists, which he drags out to show that “business is being fully considered,” in no way diminishes these worries.

Thus, regime uncertainty is a multifaceted and somewhat nuanced concept. Many economists don’t like it because it cannot be measured and compiled along with other standard macro variables in a convenient data base. But, as I have tried to show for fifteen years, various forms of empirical evidence can be and have been brought to bear to show that regime uncertainty is not simply a figment of the analyst’s imagination or an all-purpose club with which the Chamber of Commerce whacks the government’s every move to increase taxes or augment regulations. Anyone who actually manages a business or makes serious investment can readily understand the idea. Keynesian economists, who generally do not manage businesses or make serious investments, view the idea as merely something their ideological opponents toss out to obstruct the application of their “science” in policy making. It is good to have analysts such as Craig Pirrong showing that the Keynesian rejection of regime uncertainty has no firm foundation.

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Posted on: Monday, September 5, 2011 - 14:18

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Yankee, Go Home!

After the Japanese government surrendered to the Americans and their allies in 1945, the U.S. military occupied the Japanese home islands and ruled the nation for several years. In due course, however, Japan’s situation was normalized, and, moreover, in 1946 the Japanese adopted a new constitution that renounced war as an instrument of national policy:

CHAPTER II: RENUNCIATION OF WAR
Article 9:
Aspiring sincerely to an international peace based on justice and order, the Japanese people forever renounce war as a sovereign right of the nation and the threat or use of force as means of settling international disputes. 2) In order to accomplish the aim of the preceding paragraph, land, sea, and air forces, as well as other war potential, will never be maintained. The right of belligerency of the state will not be recognized.

At that point, Japan no longer represented a threat, or even a potential threat, to the United States, apart from the threat that developed later that the Japanese would sell American consumers superior automobiles and consumer electronics, among other things.

Yet the Yankees never left Japan. Their military installations remain there today, sixty-six years after Japan’s surrender. These bases are staffed by some 36,000 U.S. military personnel and more than 5,000 American civilians employed by the U.S. Department of Defense.

Major U.S. Military Bases in Japan

About three-quarters of the U.S. military bases in Japan are located on the islands of Okinawa, where the fiercest battle of the Pacific war occurred in the spring of 1945, causing horrendous losses on both sides, including many thousands of civilian deaths, and the destruction of about 90 percent of the islands’ buildings.

U.S. Military Bases in Okinawa

As if the wartime devastation were not enough, the American military personnel on Okinawa since 1945 have made themselves a chronic nuisance to the local populace, perpetrating crimes that range from automobile-related incidents, such as hit and run, to assaults and rapes. U.S. aircraft sometimes crash into civilian areas. Most Okinawans devoutly desire that these unwelcome, seemingly permanent American occupiers would get out.

And well they should; indeed, they should have done so a long time ago.

Yet, many well-placed U.S. officials and public-opinion molders have insisted, and continue to insist, that even if Japan does not threaten the United States, maintenance of U.S. forces in Japan serves to protect Americans from other threats, such as that posed by China. However, the idea that the Chinese, who rely on Americans to purchase a large share of their exports and who currently own more than $1 trillion of U.S. Treasury securities, would wish to attack the United States militarily seems more preposterous by the day. This far-fetched tale is, however, the sort of story that neocons enjoy telling their children at bedtime, when the little tykes have tired of the one about the impending Iranian nuclear strike.

Keeping U.S. military forces in Japan, like keeping them nearly everywhere else they are kept around the world, serves primarily to preserve the global empire of bases that gives U.S. generals and admirals plush commands and U.S. policymakers at the Pentagon and the State Department something to toy with when they are running out of ideas about how to make the world poorer and more dangerous. At the same time, though, the U.S. government, which must borrow 40 percent of the dollars it spends and whose once-riskless securities have begun the descent toward junk status, must expend hundreds of billions every year to maintain its imperial forces abroad. Even if these foreign bases had a genuine rationale, which for the most part they do not, the simple fact is that the government can no longer afford to maintain them.

The solution ought to be obvious: Yankee, go home!

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Posted on: Saturday, September 3, 2011 - 18:53

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One Man’s Waste Is Another Man’s Bonanza

In a recently released report, the Commission on Wartime Contracting concludes that waste and fraud have consumed at least $31 billion and perhaps as much as $60 billion of the $190 billion or so that the U.S. government has expended in grants and contracts with private individuals and companies for work in Iraq and Afghanistan since fiscal 2002. According to an article in the Richmond Times-Dispatch, “The report faults poor decision making, vague requirements and a lack of training as the chief causes and says that the waste and fraud could have been avoided with better oversight and safeguards.”

To which I am inclined to respond, not bloody likely.

Think about it: $30 billion is a helluva lot of money. At my current rate of earning, I will have to work more than 300,000 years to earn this amount—and it’s entirely possible that I will not last that long. Of course, what is called “fraud and waste” is not a sum of money that simply evaporated in the hot desert sun. Aside from the small amount literally lost, every dollar of this sum ended up in someone’s pocket.

The report tells us that the contractor workforce has sometimes included as many as 260,000 persons. Let us err on the side of a probably unwarranted presumption of innocence and suppose that only 10 percent of them are outright crooks. We have, then, 26,000 crooks pocketing an increment of at least $31 billion, or approximately $1.2 million per crooked contract worker.

Are we supposed to believe that 26,000 civilians in the contracting corps have reaped not only their already handsome, legally contracted compensation, but enough additional loot to make each of them a millionaire on top of that compensation, and nobody noticed until now? Are we simply to attribute this massive amount of misspent taxpayer money to “poor decision making, vague requirements, and a lack of training” without asking, But who got the dough?

The report’s all-too-typical way of looking at the matter may satisfy you, especially if you are given to belief in fairy tales. I am more inclined to view this whole business as not so much a mass of incompetence (though there is undoubtedly plenty of that, too) as a deliberate ongoing embezzlement on the grandest scale.

Back in the 1930s, the legendary Marine general Smedley Buter, having spent his military career running errands for U.S. banks and other companies in various parts of the world, concluded that war is not what most people take it to be.

War is a racket. It always has been. It is possibly the oldest, easily the most profitable, surely the most vicious. It is the only one international in scope. It is the only one in which the profits are reckoned in dollars and the losses in lives. A racket is best described, I believe, as something that is not what it seems to the majority of the people. Only a small “inside” group knows what it is about. It is conducted for the benefit of the very few, at the expense of the very many. Out of war a few people make huge fortunes.

Can anyone say with a straight face that he was wrong, or that the same conclusion cannot be reached today?

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Posted on: Thursday, September 1, 2011 - 12:55

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Government Stimulus: Polishing the Rotten Apples

Once upon a time in a land far, far away, there was a country famous for its apples. In fact, it produced nothing but apples and so was called Appleonia. The people ate many apples in many different ways: raw apples, baked apples, apple pies, apple fritters, and candied apples, to name just a few. They found lots of different ways to use their apples, even as fuel.

But Appleonians didn’t consume all of their apples. They saved lots and lots of apples for their seeds so they could enlarge their orchards and grow more and more. For hundreds of years, the Appleonians consumed lots of apples and made their orchards bigger and bigger. Everyone in Appleonia worked in the apple business and prospered.

It turned out though that not every place in Appleonia was perfect for growing apples. Some areas were filled with worms that just loved apples. Little by little, the worms began to infest the orchards. No one noticed until one day a young boy opened a barrel and, taking a big bite out of an apple, bit right into a worm. Undeterred, he picked up another, with the same result, and another and another. At last he found an apple that was as good inside as it was outside.

But word spread quickly that there were worms in the apples and that the worms seemed to be spreading from orchard to orchard. People quit harvesting in the infested areas and, even worse, they could no longer guarantee the high quality of their apples as they had in the past. For the first time, they produced fewer apples, and many people were put out of work.

The Appleonian government grew very worried and, after brief consultation with academic experts, came up with an idea. To put people back to work and restore faith in the apples, the government hired lots of people to polish all the rotten apples. Of course, this didn’t really work: the polished apples may have looked better on the outside, but they were still rotten on the inside. Things didn’t get any better. People were still out of work, and the quality of the apples was still hit and miss. Government officials came up with another plan. They hired another bunch of people to spray a thin layer of wax on the rotten apples. Again, their remedy was superficial: the bad apples may have looked gorgeous, but they were still rotten on the inside, and hence worthless.

The people in the government never realized that nothing short of sorting carefully through the barrels, identifying the rotten apples and throwing them out, would set things right in Appleonia’s orchards. Pouring money into efforts to beautify worm-filled apples didn’t really help; it simply prolonged the difficulty.

Here in our own time and place, we can learn an important lesson from the story of Appleonia. A simple parable cannot clarify all of the important issues involved in our situation, but it can help us to see one of its critical aspects.

Appelonia’s rotten apples are analogous to the unsound enterprises that people created during the boom prior to 2008―the houses and shopping centers that could not be sold, the mortgage loans that would not be repaid, the countless complementary investments that were made in order to take advantage of the real estate and construction run-up. These projects were, in effect, worm-infested. When the bust came, the pressing need was to liquidate them as quickly as possible, so that they would not cause other, good apples to be ruined and, especially, so that resources currently employed in maintaining and polishing them would be released for employment in the production of sound fruit that people actually value and will voluntarily pay for.

Unfortunately, for the past eighty years, liquidationist thinking has been discredited among the elites who make economic policy decisions in the United States and other economically advanced countries. Adherence to the loss-and-bankruptcy part of a profit-and-loss system is said to be cruel in politics and unsound in economics. Yet, as we gaze back on the past few years, one has to wonder: has the currently prevailing orthodoxy in economic theory and policy making proved to be a raving success? Even a brief look at what has happened recently ought to raise serious questions about the soundness of the ideas advanced by the best and brightest in the intelligentsia and the upper reaches of the policy-making elite.

During the past three years, the U.S. economy has taken a dive and, in some important ways, remained more or less submerged since it hit bottom. According to the latest government estimates, real GDP fell about 5 percent between its peak in the fourth quarter of 2007 and its trough in the second quarter of 2009. Since then it has recovered slowly, but only back to approximately the same level it had attained at its pre-recession peak. Thus, nothing has been gained during the past three and a half years.

Other aspects of the economy, however, look even worse. Unemployment, as measured by the Labor Department’s most widely cited index, has been stuck at 9-10 percent of the civilian labor force for more than two years.

Rate of Unemployment (%)

Making matters worse, long-term unemployment has increased greatly, as has part-time work by persons who say they would rather have full-time jobs. The Labor Department’s index of aggregate weekly hours worked by private employees fell by about 10 percent between June 2007 and October 2009. Although this index has increased a bit since then, in July 2011 it remained 6.6 percent below its previous peak.

Keynesians advise that in such circumstances, the federal government should increase its spending for final goods and services, and the government has taken this advice to heart with a vengeance. Real federal spending for consumption and gross investment goods increased by 18 percent between the fourth quarter of 2007 and the third quarter of 2010. Although this kind of spending has declined slightly in the past three quarters, it remained in the second quarter of 2011 almost 15 percent greater than it was in the fourth quarter of 2007.

So, we have had Keynesian stimulus aplenty, but the effects have fallen far short of putting the millions of unemployed workers back to work and propelling the economy to a high-employment rate of output. Recent economic conditions indicate that even the paltry recovery that has occurred may be petering out, and many economic prognosticators foresee another steep dive in the near-term future. Doctrinaire Keynesians insist that the economy needs a bigger dose of government deficit spending to recover fully, but less doctrinaire observers conclude that the various stimulus actions have simply failed. More important, perhaps, lenders who have financed the government’s recent spending binge are losing faith in the government’s ability to repay as promised, given the rapid recent run-up in total government indebtedness to the public.

No one is reassured, of course, by the idea that if private investors, sovereign lenders, and foreign central banks won’t continue to bankroll Uncle Sam’s profligacy, the Fed will do so. QE1 and QE2 have come and gone, with no greater success in bringing about recovery than the rest of the government’s ever-changing hodgepodge of loans, guarantees, stimulus packages, bailouts, and takeovers, and its massive borrowing to pay for the whole frantic undertaking. If the government turns to the Fed to monetize its rapidly mounting debt, we can only fear all the more that accelerating general price inflation awaits us.

In light of the foregoing facts, a radical change in policy making seems well warranted.

In politics, however, incumbency counts for a great deal. Officeholders have rigged the system by gerrymandering and other tricks to help to ensure their reelection. Established interest-groups have supported and attached themselves to the president, members of Congress, and bureaucrats from whom they secure government assistance―privileges and subsidies for their members and statutes, regulations, and administrative rulings that hobble their competitors. When a recession occurs, many of those who fall into trouble are, in effect, rotten apples. Their projects and enterprises need to be liquidated if the entire economy is to make rapid, sustainable headway. Their political clout, however, virtually guarantees that they will get bailouts and other government assistance to keep them afloat. They may float for a while, to be sure, yet they are nonetheless rotten. And they are a continuing drag on the overall economy’s recovery.

Thus, we now have, among other things, millions of houses sitting unoccupied, thousands of commercial properties similarly unused, and trillions of dollars in mortgage-related securities and derivatives whose values remain extremely iffy. Much of this debris would have been cleared away already, but for the government’s TARP, its series of stimulus-spending packages, its takeovers of huge auto and financial companies, and the Fed’s corresponding actions to flood the financial system with liquidity and prop up banks and other firms deemed “too big to fail.” Many of these incumbent firms continue to operate, even though they ought to have passed through bankruptcy proceedings long ago. Many banks are little more than zombies, living only by transfusions of reserves from the Fed and investing in little besides U.S. government securities.

All of this amounts to a rotten-apple operation. The contents of the economic barrel are still a mess. If the government and the Fed continue to pour trillions of dollars into efforts that do nothing more than polish the rotten apples, the entire contents of the barrel will become less and less valuable over time. Keynesianism was a bogus theory from the start. Thinking about why the economy succeeds or fails in terms of a handful of economic aggregates conceals everything we need to know if we are truly to understand it. Supposed experts who can’t tell a good apple from a rotten one should be kept out of the orchard. They are not helping. Indeed, they have made matters much worse at this point than would have been the case if the government had done nothing at all to reverse the recession.

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Posted on: Tuesday, August 23, 2011 - 20:03

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What if the Americans Had Established Six Nations, Rather than One?

Robert Higgs is Senior Fellow in Political Economy for The Independent Institute and Editor of the Institute’s quarterly journal The Independent Review. He received his Ph.D. in economics from Johns Hopkins University, and he has taught at the University of Washington, Lafayette College, Seattle University, and the University of Economics, Prague.

In the standard U.S. history course in high schools and universities, students are usually taught that until the Spanish-American War, the United States had followed for the most part the advice of Washington and Jefferson to steer clear of foreign entanglements. Americans had devoted themselves overwhelmingly to building their civilization here at home, whereas from 1898 onward, they began to “look outward” and to embrace the “large policy” of national greatness and foreign empire favored by such leading figures as Henry Cabot Lodge, John Hay, and Theodore Roosevelt. This way of dividing U.S. history into two epochs–before and after the onset of overseas imperialism–is fundamentally misleading.

Americans were empire builders from the get-go. From the moment the British colonists set foot on the North American continent, they resolved to engage in what the historians rather romantically and unreflectively call “westward movement,” which some nineteenth-century Americans characterized as the realization of their “manifest destiny.” This movement was itself an expression of imperialism, and some Americans, such as Thomas Jefferson and James Madison, were not ashamed to speak forthrightly of an American empire that would develop naturally as the (white) population grew and moved across the continent.

As my parenthetical qualification in the preceding sentence suggests, however, this vision disregarded one rather large fact: the continent across which these white people longed to expand was already inhabited by native Americans whose forebears had settled it more or less thickly over the previous millennia. The whites dealt with this difficulty by hook and by crook, doing whatever seemed expedient at the time–killing the Indians, driving them farther and farther to the west, buying their land, stealing their land, making treaties subsequently to be broken—to get the land they imagined to be theirs by divine design.

At the end of the American War of Independence, the Treaty of Paris established a western boundary for the new nation at the Mississippi River. Little by little, the Americans added huge chunks to the U.S. territory by means of an unconstitutional purchase of French claims to Louisiana (Jefferson conveniently set aside his belief in strict construction of the Constitution), an offer that Spain dared not refuse (for Florida), a settlement of disputed claims with Great Britain (to get the Oregon Country), and wars of aggression against Mexico (to snatch the southwest). By this continental imperialism, the United States pushed its western edge to the Pacific Ocean and its northern and southern boundaries deep in areas previously claimed by Mexico and Great Britain, as the map shows.

Imagine, however, that history had taken a different turn; in particular, that each of the major territories incorporated into the United States (not counting Alaska and Hawaii) had become instead an independent country. Each of them, except perhaps Florida, would have been fairly large as nation-states go. Each would have contained a vast diversity of natural resources, fertile lands for agricultural development, and long coastlines from which they could have engaged in cheap, waterborne international commerce. In short, each of these territories would have been completely viable as an independent country.

If history had taken this shape, how might the six nations of central North America have developed? Would they have gone to war with one another, perhaps shifting or blotting out their original borders, or might their leaders have seen the advantage of embracing continental free trade and friendly relations, perhaps even unobstructed flows of labor along the lines of the modern European Union? We can only conjecture answers to these questions.

One thing seems fairly sure, however: no one of these nations would have been as likely to develop into the global hegemon that the United States of America is today. And this outcome, one may well suppose, would have been a godsend for the people of other parts of the world because, however much today’s Americans enjoy whooping it up about being Number 1 and about “kicking ass” around the world with their far-flung military forces, those on the receiving end of this kicking do not appreciate it any more than the native Americans appreciated it back in the days when American imperialism was confined for the most part to North America.

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Posted on: Tuesday, August 16, 2011 - 20:56

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The Confidence Fairy versus the Animal Spirits–Not Really a Fair Fight

The humor columnist for the New York Times, Paul Krugman, has recently taken to defending his vulgar Keynesianism against its critics by accusing them of making arguments that rely on the existence of a “confidence fairy.” By this mockery, Krugman seeks to dismiss the critics as unscientific blockheads, in contrast to his own supreme status as a Nobel Prize-winning economic scientist.

The irony in this dismissal, as others, including my friend Donald Boudreaux, have already pointed out, is that Krugman’s own vulgar Keynesianism relies on a much more ethereal explanatory force for its own account of macroeconomic fluctuations–namely, the so-called animal spirits. The master himself wrote in The General Theory: “Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die. . . . [I]ndividual initiative will only be adequate when reasonable calculation is supplemented and supported by animal spirits. . . .” (p. 162). Because Keynes conceived of his “animal spirits” as “a spontaneous urge to action rather than inaction” (p. 161), he of course had no way to explain their coming and going or to measure or evaluate them in any way. They are as surreal as a ghost–when and why they come and go, no man knows or can know. Such is the force that drives the ups and downs of private investment in Keynesian economic theory, and such theory unfailingly drives Krugman’s commentaries on the recession and on the possibility and effective means of recovery from it.

Regime uncertainty, however, has a much more grounded basis. In my own research on the topic, I have presented evidence derived from (1) a mass of testimony by investors, businessmen, and other contemporaries, (2) voluminous historical facts on the character of government actions that reasonable people had every reason to interpret as theatening the security of their private property rights, (3) variations in the structure of investment, especially as between short-term and longer-term projects, and (4) specific twists in the term-structure of returns on private corporate bonds, as well as other relevant evidence on the behavior of financial markets.

As against this varied and substantial evidence, what does the proponent of animal sprits have to offer? Well, nothing at all. The idea is purely fanciful, the product of Lord Keynes’s fertile imagination.

However, we would do well to note that in the section of his book where Keynes introduces the idea of animal spirits, he also discusses it in a way that makes its effects somewhat similar to those of regime uncertainty as described in my own writings.

This [operation of varying animal spirits] means, unfortunately, not only that slumps and depressions are exaggerated in degree, but that economic prosperity is excessively dependent on a political and social atmosphere which is congenial to the average business man. If the fear of a Labour Government or a New Deal depresses enterprise, this need not be the result either of a reasonable calculation or of a plot with political intent;–it is the mere consequence of upsetting the delicate balance of spontaneous optimism. In estimating the prospects of investment, we must have regard, therefore, to the nerves and hysteria and even the digestions and reactions to the weather of those upon whose spontaneous activity it largely depends.” (p. 162, emphasis added)

Although Keynes greatly underestimated the degree to which investors’ expectations about the security of their property rights rest on perfectly rational grounds for fearing what a Roosevelt administration or an Obama administration might do, he recognizes that, whatever the basis for variations in their flow of animal spirits, business confidence plays an essential part of driving private investment. Paul Krugman, please reread your master’s masterpiece.

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Posted on: Thursday, August 4, 2011 - 11:41

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An Easy Solution to the Government’s Debt-Ceiling Impasse

If we credit the reports coming to us from the mainstream news media–and I am certainly not suggesting that we should–the Democrats and the Republicans are locked in a fierce struggle over whether to increase the government’s statutory debt limit. The administration and its supporters in Congress insist that taxes be increased as part of the deal, whereas congressional Republicans insist that taxes not be increased and that substantial spending cuts be made to trim the future stream of budget deficits (i.e., additions to the federal debt). Negotiations have been tense, we are told; the president recently waxed petulant and stalked out of a meeting. Heavens!

Despite the seeming impossibility of resolving this conflict, an easy solution lies at hand, and as a public service, I feel compelled to divulge it, so that the entire matter may be resolved at once and the acrimony put, as they say, “behind us” as we march stoutly toward the Brave New World that awaits us.

First, however, permit me to digress for a moment. For the past thirty years, I have been writing about the undeniable fact that the federal government has grown into a grotesquely bloated monstrosity whose size, scope, and power greatly exceed not only the limits prescribed by the Constitution, but also the limits of what men, women, and children can long endure. If this description was true in 1981–and it manifestly was–it certainly is true in 2011. So, it clearly would effect nothing more than a common-sense, morally compelling, and highly productive step if the government were, say, to reduce itself to its dimensions as of thirty years ago. My personal preference would be to return the government to its size, scope, and power as of 1929, as a first step toward further downsizing, but I do not wish to appear overly doctrinaire, and I am certainly willing to be reasonable. I am aware that some of my fellow Americans oppose such a large cutback, and, fortunately for the sake of compromise, a more generally acceptable solution lies readily at hand.

According to the government’s own budget documents, the government expects to take in about $2.26 trillion (in dollars of 2005 purchasing power) in fiscal year 2012. So, to avoid the necessity of raising the debt limit–and hence the necessity of quarreling about the matter–the government need only reduce its expenditure to that amount. Such a reduction can scarcely be described as draconian, because an expenditure of this inflation-adjusted amount would bring the government back, not to the level of 1981, and certainly not to that of 1929, but only to that of the government’s average spending in fiscal years 2002 and 2003.

All but the youngest children will recall that during 2002 and 2003, we Americans were thriving: the economy was growing, interest rates were dirt cheap, and people with only a faint pulse could secure a mortgage that covered the entire amount paid for a new McMansion. Those were obviously, in retrospect, the Good Old Days. Who can possibly object to going back only a few years, especially when we recognize how fabulously everything was humming along at that time?

This solution does not please me, of course: I much prefer that the government be cut back to the 1929 level, as a first step toward its total dissolution and privatization, in the public interest. But, again, I am not going to act childish in a crisis. The government can resolve its present impasse simply by cutting spending back to the real level it had reached–however outrageous that level might actually have been–just eight or nine years ago. I cannot imagine a more generous and eminently feasible plan, so I am hopeful that everyone will recognize at once its incontestable promise for restoring peace among members of Congress, and hence among all of the other creatures living on this green and gorgeous planet.

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Posted on: Friday, July 15, 2011 - 12:01

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Looming Treasury “Default”: Theater of the Absurd

For weeks, we have been treated to comic opera in D.C.’s theater of the politically and economically absurd. On the stage, the actors — President Obama, the Secretary of the Treasury, congressional leaders — hop about, shouting moronic lines about the national “default” that will occur unless the government’s statutory debt limit is raised, reciting Chicken Little lines about how such a default will trigger worldwide economic catastrophe. According to a report in yesterday’s Christian Science Monitor,

Facing an Aug. 2 deadline, Congress and the White House are stepping up face time to avert what the Treasury Department has called “catastrophic economic and market consequences” of a default on the national debt.

Think about this statement. Have governments defaulted in the past? Of course, they have, on hundreds of occasions over the centuries. Have these defaults triggered “catastrophic economic and market consequences”? No. When a government defaults, there are consequences, of course, including heightened reluctance of lenders to lend to the deadbeat government in the future or at least to lend at such favorable interest rates. Often partial payments of principal and interest are arranged or debts are restructured. The world keeps spinning.

Has the U.S. government ever defaulted before? Yes, in 1933, by refusing to honor the gold clauses in its bonds, the Treasury engaged in a massive default. Ironically, for mainstream economists and economic historians, the government’s abandonment of the gold standard, along with its associated default on its gold obligations, is seen as the decisive government action that stopped the Great Contraction and set in motion a recovery from the Depression. (Don’t laugh: for some time, this interpretation has been the reigning view in academia.)

If we attend to the lines being mouthed by the actors in this absurd play, however, we see quite plainly that the whole “crisis” is as phony as a $3 Federal Reserve note.

Despite a sense of urgency acknowledged by both sides, partisan positions are still far apart. Republicans say that tax increases are off the table and that a debt deal must include trillions in spending cuts at least as robust as the trillions the White House aims to add to the debt limit. Democrats aim to protect entitlements such as Social Security and Medicare and are pushing for new spending to stimulate the economy.
Mr. Obama said on Tuesday that a “balanced approach” – combining spending cuts and tax increases, including cutting tax breaks for the rich – is within reach.
“I believe that right now we’ve got a unique opportunity to do something big, to tackle our deficit in a way that forces our government to live within its means, that puts our economy on a stronger footing for the future and still allows us to invest in that future,” Obama told reporters.
In response, House Speaker John Boehner (R) of Ohio said that tax increases, even those targeting unpopular loopholes, are not politically feasible.
“The legislation the president has asked for – which would increase taxes on small businesses and destroy more American jobs – cannot pass the House, as I have stated repeatedly,” he said in a statement. “The American people simply won’t stand for it. And their elected representatives in Congress won’t vote for it.”

In short, the whole show is a farce, nothing more than a convenient occasion to seize a public-relation lever to move a mass of money out of the taxpayers’ bank accounts into the Treasury’s account at the Fed – but only for an instant, because the Treasury has plans to spend every cent it snatches and, of course, to spend even more, financing its profligacy by going even more deeply into debt (again, not the government officials’ personal debt, but yours and mine, to be serviced under threat of fines and imprisonment).

If you had maxed out your credit cards and nobody would lend you a dime, you would have to bring your expenditures into line with your income. Going ever more deeply into debt is universally recognized as ruinous for any individual or family. Yet people seem to believe that this simple economic fact of life does not apply to an organization that styles itself “the government.” Of course, this gang does have an option that you and I do not have: the ability to threaten violence against the peons it rules in order to make them hand over loot. But this option has obvious limits, and when those limits are reached, increased borrowing by the government portends the same ruinous outcome that excessive indebtedness brings to an individual or a family that consistently lives beyond its means.

In the case of government irresponsibility, however, the ruin takes a somewhat different form: it comes not to the irresponsible decision-makers themselves – members of the criminal gang can expect to get off scott free. The ruin comes to those who were foolish enough to permit such criminals to rule them in the first place, and hence to strip the society of potentially productive resources and to divert those resources to wasteful uses and to the enrichment of the gang’s principal supporters and crony capitalist pals.

Sail on, sail on, Columbia! Even if this crackpot-criminal gang gets its debt limit raised in the end — and it almost certainly will do so — its heading remains on course for a smash-up on the bigger rocks ahead.

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Posted on: Wednesday, July 6, 2011 - 15:35

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Has the American Revolution’s Rationale Lost Its Force?

The heart of the Declaration of Independence adopted by the thirteen united colonies of British North America on July 4, 1776, is as follows:

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable rights, that among these are life, liberty and the pursuit of happiness. That to secure these rights, governments are instituted among men, deriving their just powers from the consent of the governed. That whenever any form of government becomes destructive to these ends, it is the right of the people to alter or to abolish it, and to institute new government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their safety and happiness. Prudence, indeed, will dictate that governments long established should not be changed for light and transient causes; and accordingly all experience hath shown that mankind are more disposed to suffer, while evils are sufferable, than to right themselves by abolishing the forms to which they are accustomed. But when a long train of abuses and usurpations, pursuing invariably the same object evinces a design to reduce them under absolute despotism, it is their right, it is their duty, to throw off such government, and to provide new guards for their future security

On these grounds, the colonists took up arms against the long-established state under which they lived, and thousands of them perished in the struggle to secede from the British Empire.

Did the argument they advanced to justify their actions have any force? If it had force then, does it not have equal force today – nay, does it not have a thousand times greater force today than it had then?

To repeat, our ancestors declared that ”when a long train of abuses and usurpations, pursuing invariably the same object evinces a design to reduce them under absolute despotism, it is their right, it is their duty, to throw off such government, and to provide new guards for their future security.” Do the Americans of today deny that they also possess this right and this duty? And if they do possess this right and this duty, why do they continue to suffer – nay, to affirmatively suppport and celebrate – the rule of a state whose every action mocks their unalienable rights to life, liberty, and the pursuit of happiness and crushes them ever more oppressively under the weight of its presumptuous and mendacious tyranny?

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Posted on: Monday, July 4, 2011 - 23:24

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World War II: Still Being Touted as the Quintessential Keynesian Miracle

Someone must have imagined that my hopes for improved economic understanding might be excessively optimistic today and thus needed to be curbed to restore my normal emotional balance, because that person undertook to smash any such hopes to dust by e-mailing me a link to a HuffingtonPost article by Paul Abrams, “Economically, World War II Was Stimulus on Steroids.” This screed turns out to be an ostensible macroeconomics lesson composed in equal measure of economic foolishness, historical ignorance, and ideological tendentiousness – the veritable epitome of a worse-than-worthless contribution to public enlightenment.

The opening paragraphs indicate the direction of Abrams’s argument:

The next time someone argues that the New Deal failed, and only the Second World War ended the Depression, as ‘proof’ that government spending does not work, one can respond with the details of economic growth and unemployment reduction up to 1940, or one can ignore the claim and thank them for making your case for massive government spending in a deep, broad recession.

Right wing politicians are loathe to credit the New Deal with any success in hoisting the United States out of the Great Depression, but credit World War II for that achievement, believing that that somehow disproves Keynesian economic theory.

That claim, however, undermines their entire premise.

Abrams concludes that “massive government spending at a time of severe economic downturn and dislocation can indeed get an economy humming again,” as World War II shows; the New Deal was merely too timid. He seems unaware that his argument merely restates the fallacy-ridden hodge-podge of conventional wisdom about how World War II “got the economy out of the Depression” that has dominated the thinking of economists, historians, and the public ever since the war itself.

When I began to teach U.S. economic history at the University of Washington in the late 1960s, I quickly realized that this tale of the wartime “Keynesian miracle” could not withstand critical scrutiny once one went beyond the barest account of it in terms of the elementary Keynesian model and the standard government macro measures, such as GDP, the consumer price index, and the rate of civilian unemployment. Almost immediately I saw that unemployment had disappeared during the war not because of the beautiful workings of a Keynesian multiplier, but entirely because about 20 percent of the labor force was forced, directly or indirectly, into the armed forces and a comparable number of employees set to work in factories, shipyards, and other facilities turning out war-related ”goods” the government purchased only after forcing the public to pay for them sooner (via wartime taxes and inflation) or later (via repayment of wartime borrowing). Thus, the great wartime “boom” consisted entirely of (1) some people’s mass engagement in wreaking death and destruction and (2) other people’s employment in producing supplies for these warriors after the government’s military labor drain, turning out ”goods” never valued by consumers or private producers in voluntary transactions, but rather ordered by government functionaries and priced completely arbitrarily in a command-and-control economy. In no sense was the alleged ”wartime prosperity” comparable to real, normal prosperity. The pervasive regimentation, rationing, price controls, direct government resource allocations, and forbidden forms of production (e.g., civilian automobiles) should have served as a tip-off.

After teaching my own students along these lines for many years, I eventually began to write articles and books pulling together my various studies. The most coherent of these books is my Depression, War, and Cold War, published originally by Oxford University Press in 2006. For all of the good I’ve done in correcting people’s understanding of what happened to the U.S. economy during World War and what lessons one might justifiably draw from that experience about, say, the scientific validity of the Keynesian model or its related fiscal-policy implications, I might just as well have held my breath and turned blue. Here we are in June 2011, and millions of Americans are being presented with the purest potion of economic misinformation one can imagine, an account in no way superior to those the young Keynesians were peddling so confidently in 1944, when I was born. Perhaps my mother ought to have strangled me in my crib, to spare me the bitter disappointment of seeing the research and writing I’ve carried out over more than forty years prove to have been completely in vain.

For the Paul Abrams’s of this world, of course, none of this makes the slightest difference. They are at pains not to understand how the economy actually works or to endorse policies that promote its greater productivity, but only to concoct a plausible rationale for the government’s taxing “the rich” more heavily and spending oodles of money on a laundry list of leftist idols — government “infrastructure,” green energy-conservation programs, high-speed rail, and the rest of the wasteful and economically foolish purposes that progressive politicians espouse to feather their own nests and enrich their cronies and political dependents at public expense. If they haven’t learned any sound economics by this time, chances are slim to none that they will ever learn any, but I cannot believe that they care about such learning, in any event. Politics is the name, plunder’s the game.

There’s a lesson here, besides the obvious one that public discourse consists overwhelmingly of ideological sound and fury, signifying nothing solidly connected to reality. For me, the main lesson is: mommas, don’t let your babies grow up to become economic historians. If you do, you only put them in line to have their hearts broken.

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Posted on: Wednesday, June 29, 2011 - 00:48

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Money versus Monetary Base: A Basic Yet Critical Distinction

As more and more people have taken an interest in monetary affairs — especially in the Fed and its various operations — in recent years, many people have joined the discussions related to these matters, especially on the World Wide Web. In reading these posts over the years, in particular in reading the comments on a post I placed recently at The Beacon, I have been struck by the frequency with which the writers reveal that they do not understand a basic conceptual matter in regard to money, monetary policy, and the Fed. That matter is the difference between the monetary base and the money stock.

In the data compiled by the Fed and used by analysts in various ways, the monetary base (sometimes called “high-powered money” or “base money”) consists of currency — that is, Federal Reserve notes, the legally authorized, circulating paper money denominated in U.S. dollars issued by one of the Federal Reserve System’s regional banks — plus deposits that commercial banks and other “depository institutions” hold as reserves in accounts at the Fed. This sum is known as the monetary base because it forms the foundation on which commercial banks may extend loans to customers and make investments by means of establishing checking accounts (checkable deposit accounts) for those customers or security sellers.

In a fractional-reserve banking system, such as that in the United States and most other countries, banks are legally required to hold a certain percentage of their deposit liabilities (including those they create as just described) as reserves at the Fed. If they hold more reserves with the Fed than their current accounts require, those reserves as denominated “excess reserves.” These may be used, of course, to extend additional loans and make additional investments in securities until the bank has reached a condition in which it has used up all of its legally “excess” reserves.

As a fractional-reserve banking system creates new checking accounts for its customers, it adds to the money stock, which is the set of all highly liquid assets that are most readily exchangeable for goods and services. Note, however, that the precise definition of the money stock is necessarily vague: exactly which liquid assets ought to be counted as “money” and which ones ought not to be counted cannot be resolved by finding the “correct” answer; there is no correct answer. What one would wish to count depends on the question one seeks to answer by making reference to the amount of “money” in the system.

Therefore, one finds that many different statistical series are created and employed by economists and financial analysts. These are denominated by acronyms such as M1, M2, M3, MZM, and so forth. There is no conspiracy or attempt to conceal anything in this way of dealing with the data, but only a frank recognition that “money” is not a clearcut economic entity, and indeed its composition may change — and often has changed in the past – as economic and financial conditions and transaction practices vary.

It is common to say that the Fed and other central banks have the power to “create money out of thin air,” that is, out of nothing more than their own declaration that new deposits are now available to a bank at the Fed (often in exchange for a bank’s asset or collateral). This common saying, however, is not quite right. In fact, the Fed has only the power to create new base money. If the banks that acquire that new base money in their accounts do not use it to make new loans or purchase new investment securities, it simply sits there at the Fed: in that form, it is not money because it is not a balance that can be exchanged directly for goods and services. For the Fed to create money, then, it must have the cooperation of the banks, which use the newly created base money to establish new checking accounts for loan customers or security sellers.

This is the situation to which my previous post called attention: namely, that since August 2008, the Fed has created a fantastically huge addition to the monetary base, about $1.5 trillion dollars, yet the banks have let the lion’s share of this addition lending potential sit at the Fed unused, hence untransformed into increases in the money stock.

FRED Graph

For example, M2, a commonly used measure of the money stock, has increased by only about $1.244 billion, or about 16 percent since August 2008. Whereas the “money multiplier” associated with additional base money might normally have been expected to be perhaps 10 or more, turning $1.5 trillion of new base money into $15 trillion of newly created money stock (and thereby triggering hyperinflation), in the present case, the addition to the money stock has actually been smaller than the addition to the monetary base — that is, the money multiplier has been less than one because of the banks’ not making use of the new lending potential it gives them.

FRED Graph

This difference — this breakage, as it were, of the previously prevailing relation between the monetary base (which the Fed controls) and the money stock (which the Fed and the banking system and its customers jointly control) — is the essence of the puzzle to which I called attention in my previous post. Many people have offered plausible explanations for it, but many of the lay commentators’ comments are flawed by a failure to appreciate correctly the distinction between the monetary base and the money stock. Intelligent engagement in this discussion requires that one master this elementary yet critical distinction.

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Posted on: Sunday, June 26, 2011 - 20:04

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The Continuing Puzzle of the Hyperinflation that Hasn’t Occurred

Since late December 2008, the bank prime lending rate — the interest rate banks charge their best corporate customers — has remained steady at 3.25 percent.

FRED Graph

Meanwhile, during the same period, the excess reserves that commercial banks hold at the Fed have increased from $2 billion in August 2008 to $1.513 billion in May 2011.

Ordinarily, one would have expected this development to produce hyperinflation of the general price level. However, the price level has increased quite moderately, and for a while many analysts warned that deflation was the greater risk. Despite a slight increase in the price level’s rate of growth in recent months, the index of prices paid by all urban consumers has increased by only about 6 percent in the three and a half years since the beginning of 2008. Not only has hyperinflation failed to appear; even garden variety inflation of prices in general has been extremely low by the standard of recent decades.

FRED Graph

The preceding combination of events poses a great challenge to economic analysts. How can we explain that the fantastically enormous explosion of bank reserves has not given rise to bank lending that would greatly expand the money stock and thereby drive up prices in general?

The most obvious answer, of course, is that the banks are simply sitting on the reserves, rather than lending them to customers. And why are they doing so? The usual answer is that since late 2008, the Fed has paid the banks a rate of interest on their reserves at the Fed. This interest rate has recently been in the range 0-0.25 percent. Although this is not nothing, it verges very closely on nothing. And if one notes that the purchasing power of money has fallen at least a bit, it is clear that the banks are realizing a negative real rate of return on their holdings of excess reserves at the Fed.

Moreover, they are doing so notwithstanding that they appear to have the option of lending at 3.25 percent to their best corporate customers and at higher rates to their less creditworthy customers. Why are they foregoing the opportunity to earn huge sums by switching out of excess reserves at the Fed into commercial loans and investments? The answer would seem to be that that are so frightened of the risk associated even with loans to their best customers that they are loath to lend. After some volatility up and down and then up again between the summer of 2008 and early 2010, total loans and investments of all commercial banks have settled for more than a year at a level only about 2 percent greater than their level at the beginning of 2008. This increase of about $200 billion amounts to only a small fraction, about 13 percent, of the increase in their excess-reserve balance at the Fed during the same period.

FRED Graph

In these circumstances, some economists have taken to arguing that excess reserves no long constitute “high-powered money,” that they no longer belong to the monetary base, and therefore they have not proved to be the fuel for hyperinflation that nearly all economists would have expected them to be prior to the past four years of anomalous experience.

I am not convinced. First, I am not convinced that these gigantic sums will not, sooner or later, still become the fuel for hyperinflation, or at least for a greatly accelerating rate of general price inflation, which economists expected they would be before the recent recession and all of the government’s and the Fed’s extraordinary responses to it occurred. Second, I am not convinced that the banks will remain content forever with earning a negative real rate of return on their holdings of $1.5 trillion in excess reserves now languishing at the Fed. If they were to realize only the difference between the rate the Fed is paying them and the rate they would earn by lending these funds exclusively to prime customers — an increase of 3 percent on their return — they would gain an additional $45 billion in income. That’s a great deal of potential income to leave lying on the table, and it might be even greater if we factored in the additional income they might earn by lending to less-than-prime customers at greater rates. I understand, of course, that banks are seeking to repair their damaged balance sheets, in light of their recent debacle in real-estate-related investments of various sorts and in conformity with the new Basel requirements for increased bank capitalization. Still, I am not convinced that these consideration can account fully for the very curious conditions now existing in the banking industry.

Of course, my lack of conviction in the new wisdom may be groundless. This time, everything really may be different. But as an economic historian, as well as an economist well behind the cutting edge of his profession, I am not ready to latch onto this latest “this time it’s different” explanation, at least not until a long time has passed and my skepticism has been proved baseless by long-sustained counter experience. At the moment, the conjunction of recent macroeconomic events still seems to me to pose a great puzzle.

Perhaps a part of the answer relates to the regime uncertainty about which I have written from time to time during the past three years, harkening back to my earlier writing about its significance during the second half of the 1930s, during the so-called Second New Deal. It would hardly be astonishing if such worries were now contributing to the extreme risk aversion banks are manifesting. Moreover, perhaps for the same reason, potential borrowers are not exactly clamoring for loans, and indeed many corporations are sitting on huge cash hoards of their own. Interesting times, indeed.

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Posted on: Friday, June 24, 2011 - 00:24

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Expel These Vultures

If a buzzard were to fly about three miles to the southwest from my home in rural St. Tammany Parish, Louisiana, he would come to St. Joseph Abbey and Seminary College, a monastery and seminary maintained by Benedictine monks. When he arrived, however, he would find other vultures already hovering over the abbey.

These vultures are funeral directors whose cartel privileges are legally enforced by the Louisiana Board of Embalmers and Funeral Directors, one of the countless predatory bodies the state legislatures have seen fit to create during the past century and a half in order to protect unscrupulous sellers from honest competition and, along the way, to grease the palms of the co-conspiring politicos, all at the expense of consumers.

A few years ago, seeking a new means of supporting the abbey and themselves, the monks began to produce and sell simple yet entirely serviceable wooden caskets. Where’s the crime in their doing so? Well, some people are willing to take any despicable action whatsoever to suppress competing sellers. One such despicable party was Boyd L. Mothe, Jr., vice president of Mothe Funeral Homes, who brought a formal complaint against the abbey’s casket sales in 2008, based on the state’s restriction of the trade.

On Monday, June 6, a trial will take place in U.S. District Court in regard to the abbey’s plea for declaratory and injunctive relief from the state’s enforcement of its law that only licensed funeral directors may sell “funeral merchandise.” The monks are being represented pro bono by the Institute for Justice.

Let us pray that the court sees fit–if only to do something out of the ordinary–to reach a just decision in this case. The monks surely deserve relief from the menacing presence of the vultures hovering over their beautiful monastery.

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Posted on: Saturday, June 4, 2011 - 19:54

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The Drug War's Ravages in Guatemala

Yesterday, after I had participated in the commencement exercises at the Universidad Francisco Marroquin, in Guatemala City, I was interviewed by a reporter for Prensa Libre, an important newspaper in this city. I did not know what the reporter would ask me, but I supposed that his questions might have something to do with economic affairs or with the reasons for my having been given an honorary degree by the university.

To my surprise, all of the reporter’s questions pertained to the drug war in Guatemala—its causes, what the government’s policy should be, how the government might combat the cartels more effectively, and so forth. I used this occasion to emphasize the same points that I—along with many others—have been making about this so-called war for decades: in particular, that the possession, use, and commerce of narcotics should not be legally forbidden; that the major consequence of this prohibition has been the creation of a black market in an artificially high-priced, widely demanded set of goods; that this black market has attracted persons willing to take risk, violate the law, and use violence to settle disputes among themselves and their rivals; that the government’s conduct of the drug war has contributed greatly to the massive corruption of the police and the political authorities; and that the general public has suffered in a variety of ways as a result of the policy, most significantly because of the widespread killing that it has occasioned, especially in Colombia and Mexico, but also because of its huge expense and its grave damage to civil liberties in the United States and elsewhere.

I got the feeling that these views were not exactly what the reporter was looking for. The character of his questions led me to suspect that he was interested in hearing my views about how the drug war might be fought more effectively. But I have no way to know, of course, so my hunch may be completely off base.

In discussing the economic conditions and prospects of Guatemala with my colleagues at UFM during the past few days, I have been somewhat surprised by the frequency with which the conversation has returned to the drug war and its effects on this country. Guatemala apparently has become a focus for a large volume of the transport and financial dealings that the narcos carry out as part of their vast international business. They are insinuating themselves deeply into legal businesses and government activities here—and of course into politics, as well—and thereby becoming a major force in determining the country’s economic fortunes, for better or worse. They are also provoking a palpable degree of fear among the local people. Private security personnel are on display everywhere in Guatemala City in great numbers; the private-security industry must be a major source of income and employment here.

Meanwhile, in the United States, most of the people go on with their daily lives unaware of the widespread harm that their support for the U.S. drug war—and its hugely destructive spillovers around the world—is causing. This whole policy is almost incomprehensible to some intelligent people here in Guatemala. They wonder how a segment of the U.S. public, consisting of puritanical busybodies willing to support the use of coercive force against their neighbors’ private use of certain substances, can keep in place for decades such a horrific policy.

I explain to my friends that by this time, the U.S. politicians have learned that the coercive-busybody faction can be satisfied and their votes garnered without seriously offending another faction that opposes the policy and that the bulk of the public is simply sleepwalking through life while the drug war rages around them, barely out of their sight. Moreover, the drug war has deeply entrenched an enormous police apparatus, enriched and militarized local police across the country, and given the authorities a fine means of enriching themselves by corruption and covert cooperation with the narcos. If anyone wanted to find an example of a public policy whose overall benefits (if indeed one even considers such benefits to exist) fall dramatically short of its overall costs, no better example could be found.

Although most Americans have long since grown accustomed to and complacent about the drug war, which has become for them a sort of public-policy background noise, the people of small countries such a Guatemala cannot be so blase about it. It is altering the very fabric of political and economic life in their countries, and it is causing violence, kidnapping, robbery, and murder to flourish in places where life would otherwise be much more peaceful. To anyone who seriously ponders the drug war, its manifest evil ought to be undeniable, yet many Americans continue to support it, more or less, and only a small minority of Americans appreciates it for the almost indescribably destructive madness that it truly is.

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Posted on: Tuesday, May 10, 2011 - 15:46

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CHAPTER II: RENUNCIATION OF WAR

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