From my co-author Charles Rowley, in the Daily Telegraph: "Adam Smith would not be optimistic in today's economic world: Adam Smith once commented that "there is a great deal of ruin in a nation". He meant that bungling governments imposed only a limited check on the economic performance of a Great Nation." This article accompanies the launch of Economic Contractions in the United States. For regular readers of this blog I'll stop to point out my... differences of emphasis... as appropriate:
As Nathanael Smith and I show in our study of US economic contractions, Adam Smith would be much less sanguine were he confronted by today's financial crisis and the US government's response. Indeed, it is not impossible that the US will experience the kind of economic collapse from first- to third-world status experienced by Argentina under the national socialist governance of Juan Peron.
"Not impossible" is so weak that it makes the claim innocuous, I suppose, but this seems like an exaggeration, and it seems to conflict with the 7th chapter of Economic Contractions, where we predict that "profligate deficit-spending and interventionism" will produce disillusionment and a conservative revival (p. 97)-- a prediction that events seem to be bearing out.
The US economy suffers from a growing culture of indebtedness that has increasingly contaminated the federal government since 2001 and has spilled over dramatically into private household behaviour. The combination of the ill-conceived fiscal-furnace fired by President Bush and the US Congress and the reckless monetary-furnace fired by Alan Greenspan and Ben Bernanke throughout the period 2001-2007, created unsustainable housing market and stock market bubbles whose collapse brought on the financial crisis and economic contraction of 2008-2009.
I would put the charge in more measured terms. Fiscal policy under George W. Bush was less expansionary (smaller deficits as a share of GDP) than under Ronald Reagan, even though the US was at war in the Bush years and not in the Reagan years. (At a time when Obama and the Democratic Congress are redefining "reckless" in the upward direction at a rate of $100 billion a month or so, it seems strange to use the term for the Bush administration, though the Bush administration should certainly have known better.) And while interest rates stayed low in 2003-04 for too long after recovery had begun, they then rose steeply, so "throughout the period 2001-2007" seems to make the charge too broad. Even the low interest rates of 2003-04 seem more like a serious technical mistake combined with having the wrong Fed policy rules-- housing should have been included in the CPI-- than "reckless." And dating the problems to 2003-04 would seem to absolve Bernanke and concentrate responsibility on Greenspan.
What led to the bubble was that (a) fiscal and monetary policy were expansionary at the same time for the first time since the 1970s, and (b) house prices were-- we argue, mistakenly-- excluded from the price index, causing the Fed to see "low" inflation at a time when house prices were rising at well over 5% per year. What I find ironic is that, in a sense, the crisis is Osama bin Laden's revenge. Bin Laden wanted to deal a devastating blow to the US economy. Determined to deprive him of this victory, Bush and Greenspan adopted expansionary fiscal and monetary policies that lifted the economy out of what could, and maybe should, have been a deep recession in 2001. As a result, they inflated a debt bubble and made the next crisis sooner and deeper. Fortunately, al Qaeda was ruined by the war in Iraq, so bin Laden's victory is Pyrrhic. But if the government had let the 2001 recession play itself out naturally, there might not have been any 2008 crisis.
The policy responses to the debt bubble demonstrate crude political consideration rather than economic understanding. If excessive government indebtedness is a major source of the problem, why increase the government debt? Why encourage households to go yet further into debt?
The prognosis is catastrophic if projected government policies are not cut back. According to the White House's own estimates, the federal budget deficit in 2009 will be $1.6 trillion, approximately 11.2pc of the overall economy, the highest on record since the end of the Second World War. In 2019, the national debt will represent 76.5pc of the US national economy, the highest proportion since just after the Second World War. In such circumstances, the international reserve status of the US dollar will not survive. As it fades, so interest rates on government securities will rise and the real burden of servicing the debt will increase. In such circumstances, the US economy will teeter on the edge of a black hole.
Hmm... why bring in "the international reserve status of the US dollar?" I don't remember anything about that in the monograph. Do we have-- does anyone have-- a theory relating government debt to the viability of a reserve currency? Personally, if there were some way to transition out of a dollar regime without global chaos, I think it might be nice not to own the world's reserve currency: I think being able to print the world's reserve currency causes a form of "Dutch disease," undermining the competitiveness of our industries and fueling excessive growth of government. Also, why would more debt cause the US economy to "teeter on the edge of a black hole," rather than, say, acting as a drag on growth and depressing living standards for decades-- as it has arguably done in Japan? Government debt in Japan and Italy is way above 76.5% of GDP; both countries have suffered malaise rather than crisis.
Prosperity and full employment in the US will only be restored by a return to laissez-faire capitalism. Our study outlines a radical, but politically feasible, approach. Monetary policy should be expansionary. But, on the micro-economic side, tariffs and other trade barriers should be repealed unilaterally; a "Right-to-Work" Act should reduce the minimum wage and curtail the powers of unions; and business regulation should be reduced. Individual banks and their counterparties should not be bailed out, although the system should be protected by ensuring that failing banks are wound up in an orderly fashion – this is the only way to restore market discipline.
A little late not to bail out individual banks, no? Rather say that laws and policies should be rewritten so as to prevent future bailouts (except of insured deposits through the FDIC). And is it really "politically feasible" for "tariffs and other trade barriers [to] be repealed unilaterally?" Maybe! I wouldn't rule out the possibility that bold, visionary political leadership can make the politically impossible possible -- after all, Obama seems to have made people dislike unions and appreciate the health care status quo! -- but that is as much as to say that the range of the "politically feasible" is very broad.
Rowley and I found enough to agree on to put a book together, but he might have a tendency to overclaim.
MORE: "Barack Obama accused of making 'Depression' mistakes: Barack Obama is committing the same mistakes made by policymakers during the Great Depression, according to a new study endorsed by Nobel laureate James Buchanan." (Daily Telegraph):
"Endorsed by Nobel laureate James Buchanan." That's brilliant marketing. But it's not false advertising, for here is Buchanan's Frontispiece:
A comprehensive and coherent assessment of the current economic contraction, one that largely rebuts attribution of failure to capitalism or the market. The targets become practicing politicians of all parties, whose cumulative mistakes have now hurt us all. We have learned some things to reduce the severity of the current contraction. But we have made no progress toward putting limits on political leaders, who act out their natural proclivities without any basic understand of what makes capitalism work.
Anyway, here's what Edmund Conway of the Telegraph has to say:
His policies even have the potential to consign the US to a similar fate as Argentina, which suffered a painful and humiliating slide from first to Third World status last century, the paper says.
There are "troubling similarities" between the US President's actions since taking office and those which in the 1930s sent the US and much of the world spiralling into the worst economic collapse in recorded history, says the new pamphlet, published by the Institute of Economic Affairs.
In particular, the authors, economists Charles Rowley of George Mason University and Nathanael Smith of the Locke Institute, claim that the White House's plans to pour hundreds of billions of dollars of cash into the economy will undermine it in the long run. They say that by employing deficit spending and increased state intervention President Obama will ultimately hamper the long-term growth potential of the US economy and may risk delaying full economic recovery by several years.
Excellent. The title of the Telegraph piece may slightly overplay the 'Depression' analogy -- while we do identify some similarities with policies from the Depression era, monetary policy is (no thanks to Obama) just the opposite, and we haven't seen anything like the crazy tax hikes of Hoover and FDR yet though there are some ominous signs -- but this last paragraph nicely captures a central argument of the book. Conway continues:
The study represents a challenge to the widely held view that Keynesian fiscal policies helped the US recover from the Depression which started in the early 1930s. The authors say: "[Franklin D Roosevelt's] interventionist policies and draconian tax increases delayed full economic recovery by several years by exacerbating a climate of pessimistic expectations that drove down private capital formation and household consumption to unprecedented lows."
Heh. If Rowley and I get credit for debunking the myth that FDR's Keynesian New Deal got us out of the Great Depression, that would be as unfair as Columbus getting credit for debunking the myth that the world is flat. To our cost, this myth remains potent at the popular level, but among economists I don't think even Paul Krugman would defend it. Rather, Keynesians claim that WWII got us out of the Great Depression. This is also debatable -- "GDP" grew, but should bombs and guns and tanks count as GDP, when they don't contribute to human happiness; or if they do count as GDP, don't we need some more appropriate way of measuring the economy's contribution to human well-being, which would likely put paid to the odd notion that WWII was an economic golden age? -- but it has no bearing on the episode Rowley and I deal with, namely the 1930s. It's rather odd that at this late date anyone can make headlines with what ought to be a truism, namely that the New Deal exacerbated, rather than "got us out of," the Great Depression, but if that's still news to a lot of people, then those headlines need to be made. Conway continues:
Although the authors support the Federal Reserve's moves to slash interest rates to just above zero and embark on quantitative easing, pumping cash directly into the system, they warn that greater intervention could set the US back further...
And then proceeds with quotes from Rowley and Buchanan, already quoted above in this post. I'm glad that the message is clear that we support quantitative easing. On that point we're basically Milton Friedman-type monetarists. Too bad our advocacy of immigration reform and Social Security reform doesn't seem to be making it into the reviews so far!