New School Politics

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In front of a House committee on Wednesday Ben Bernake claimed that lagging growth is the central bank’s chief concern.

This means only one thing: that the Federal Reserve will cut rates again in the relatively near future. His claim that growth is the chief concern also indicates that climbing inflation and the falling dollar are of secondary concern. The reality of both economic slowdown and climbing prices are beginning to revive worries of impending stagflation, which could be revealing itself for the first time since the 1970s and early 80s. The dilemma for Bernake is balancing these two inverse herrings. At this point, if he is indicating that he will cut rates to bolster short-term growth he is willingly accepting more inflation and a weaker dollar.

Yet there is still another side-effect that the fed is accepting: the stifling of long-term growth. This never gets talked about much on the news or by economically illiterate congressmen, but for the simple fact that more rate cuts encourage consumption at the cost of savings, we will be capital accumulation for usage of our economic resources in the short term. Its a simple matter of distorting time prefferances.

Additionally, unanswered is how rate cuts will actually revive the economy’s real capacity to produce and grow. While easier money encourages more spending, and thus creates the image of more growth by boosting aggregate demand in the immediate, it does not actually represent a real or sustainable spike in productivity. If rate cuts did boost real output then there would be no reason for the Fed to stop at 3%, they would just keep cutting and cutting the FFR down to 1% or less, and then keep it there. But the fact is that loose banking policy does little more than increase the money supply–which is the reason we are presently seeing more inflation–not wealth, contrary to the Keynsian and Mercantalist doctrines which apparently survive still today.

Another issue rarely addressed is the possibility of reinflating any bubbles in the economy by repeated rate cuts. Recall the slowdown in ‘01/’02 and how the Fed aggressively debased interest rates all the way to one percent by 2003. One of the consequences of the absurdly low rates was that investors that went bust in the tech bubble of the late nineties were to an extent bailed out by easy money and thus a standard of incentives were set which said that ‘even if you make bad investments, you will not be made to bear the full burden of your decision-making.’ Today, we may be seeing the deja vous in the housing market.

Henry Hazlitt once said, “The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.” Currently, I think many in the public eye are not acting as “good economists” by this measure. Even many economist have jumped on the fiscal/monetary stimulus bandwagon without enumerating all the costs and benefits of those policies. Until and unless many more Americans, economists, and policymakers start heeding Hazlitt’s advice, we should all become accustom to the patters of moderate booms and busts that we have witnessed in recent history.

Popularity: 40% [?]

President Bush’s new stimulus planned, now approved by Congress, will send checks of at least $300 to over 100 million American in an effort to jumpstart the lagging economy.  For the plan to work it is necessary that citizens receiving these rebates go out and consume right away.  However such a plan is only a minor fix and will end up exacerbating the original problem that caused this recession: debt. 

The major event leading to the downward economic spiral we find ourselves in today was the subprime mortgage crisis, which essentially meant that many new lower income bracket homeowners could not pay their mortgages, leading the banks to have to foreclose.  Furthermore, Americans, as a whole, owe more money than they are taking in because of widespread ignorance about how to properly use a credit card and budget.  Our government is even having major issues with budget management as our outstanding national debt is approximately $9 trillion, with over $2 trillion of that being owed to foreign governments.  In fact, we borrowed the $168 billion for this stimulus package from China.   

At a time when the American people and government have so much debt to pay off, how does a plan help in which the government has to borrow billions of more dollars, and encourages the people to go further into debt by buying a new television, computer or DVD player?  Temporarily there will be a surge in profits and sales, but as soon as monthly payments for product with low down payments and high interest rates are due we will see how the economy does then.  My prediction is not too good. 

Popularity: 48% [?]

With economic prospects not looking so hot and the compromise bill for fiscal stimulus in limbo in the Senate, more spending appears to be the consensus among the public regarding how to cure the ailing economy. Right now we stand to see around $150 billion in mainly expended to “prime the pump” at some point this year.

But while stimulus may be the conventional wisdom, a variety of legitimate voices still exist against the Keynsian rehash. Here is a list compiled by Greg Mankiw of such voices:

• Andrew Samwick
• Steven Landsburg
• Robert Samuelson
• Russell Roberts
• James Hamilton
• James Cramer
• Arnold Kling
• Donald Boudreaux
• Alan Reynolds
• Bruce Bartlett
• George Will
• Alex Tabarrok
• Bill Thomas and Alex Brill
• Michael Kinsley
• Steve Entin
• Dan Mitchell
• Walter Williams
• Thomas Sowell
• Ricardo Hausmann
• Bob McTeer
• Willem Buiter

It is worth noting that I too am against any notion of “fiscal stimulus.” Some of my favorites, which on the whole best represent my opinion, include Economists Steven Landsburg, Russ Roberts, Don Bourdeaux, Arnold Kling, Alex Tabarrok, Walter Williams, Thomas Sowell and political commentator George Will.

The underlying theme of their criticism is that there is nothing magical about the stimulus and it does little more than redistribute existing wealth within the economy. The main effect it has is to encourage consumer spending (as opposed to savings) in order to boost short term demand. Unfortunately this is the complete opposite of what our economy needs right now. What the economy is experiencing is essentially a readjustment of how it spends its money. Years of extremely low interest rates an loose credit caused mal-intestment and overspending–especially in real estate–up until the current point in time in which investors began to realize that real savings was not enough to support the expensive borrowing that was going on.

In other words, the root of the economic problems we are facing today are the consequence of overspending. And the proposed rememdy–even more spending–can only further inflate these problems and postpone even greater economic woes.

Popularity: 56% [?]

George Soros is convinced that the world is about to enter a serious recession.  Unfortunately, it seems as if most of the financial world is similarly convinced. The latest trend in stock markets seems to be, “Sell!  Sell!” as traders don’t know what’s going to happen in trading today in the United States, which just opened at 10AM.  The Federal Reserve, in an attempt to head off the recession, cut interest rates last night in a rare between-meetings announcement.   News from the Asian markets isn’t good, with Forbes saying that the environment is rather negative.  One Japanese trader seems to have summed up the mood.

“It’s like a funeral in here,” said Ken Masuda, senior equities dealer at Shinko Securities in Tokyo.  ”No one knows what’s going to happen tonight in New York.  It’s like we’ve gone blind, you don’t know what’s coming.

“Until we see New York, all we can do is sell.” 

We can hope that the United States can stave off recession with an economic stimulus package and without pushing the stock market lower.  Unfortunately, the stimulus package seems far off, as Democrats and Republicans cannot agree on how to reinvigorate the economy.  Sen. Charles Schumer [D-NY] predicts that the stimulus package will be passed some time in March.  If the market drops today as it has been predicted, this may be too late.  Europe, meanwhile, is convinced they won’t be affected by the US’ possible recession.  We’ll be covering the financial situation all day, and we hope that our next post comes with good news instead of bad.  In the meantime, as Eftychis suggested, stick to Forbes, The Financial Times, The Wall Street Journal, Bloomberg News, and financial aggregators like Google Finance & Yahoo Financefor up to the minute reports on the stock market’s position.  As of this writing, the NASDAQ was down approximately 117.68 points, or 5.03%, while the DJIA has seen a drop of 59.91 points [or .49%].

Popularity: 99% [?]