Demand Side, the Book

2011-01-29T09:43:00.000-08:00

Inflation:

In India and China, food price rises are rampant. We have argued that this is a worldwide financial bubble due to speculation in financial markets on commodities, via index traded funds and other market instruments. This is the same experience as the first half of 2008.

But this is not the whole story. Food and energy price spikes are also due to the ability of some of the population to pay the higher prices.

Minsky assumes that the wages in the consumer sector are the same as the wages in the investment sector, but this is not the case. Design, high tech production, and higher skill sets are all more common in production of investment goods, from roads to machinery, from plant to equipment, than in production of consumption goods.

When investment capital flows into a country, it creates the dynamic of Minsky's -- or Kalecki's -- two-part economy. The more investment, the more workers are in investment goods production, that is, the higher the ratio of investment goods labor to consumption goods labor, the higher will be inflation. More workers are bidding for the same consumption goods, and on the other side of the coin, the costs and profits of investment have to be built into the price structure.

The experience is that consumption goods workers have stagnant incomes and rising prices are extremely dangerous for them. Investment goods workers can pay the price, until the bubble breaks. And in the end, the bubble breaks, asset values drop, investment stops, growth stops. Sound familiar?

2009-10-20T17:15:00.000-07:00

Table of Contents

Introduction

Part I: Premise and Overview

Chapter 1: Many Parts
Chapter 2: Three Challenges
Chapter 3: Premise and Overview

Part II: The Roots of Demand Side

Chapter 4: John Maynard Keynes and the Great Depression
Chapter 5: Leon Keyserling and the Prosperity of Postwar America
Chapter 6: John Kenneth Galbraith and the Rise of the Industrial State
Chapter 7: Hyman Minsky and the Rise of Economic Instability
Chapter 8: James K. Galbraith and the Predator State
Chapter 9: Joseph Stiglitz and Globalization
Chapter 10: George Soros and the Way Markets Work
Chapter 11: Public Goods and the Commons

Part III: Evidence

Chapter 12: An Anecdotal History of Postwar America
Chapter 13: Economic Performance by President
Chapter 14: Demand Side Tools, Forecasts and Preview of Vol. II

Part IV: Theory

Chapter 15: Structuring the Market
Chapter 16: Productivity Explained - The Rule of 8
Chapter 17: Investment Explained - The Rule 0f 70
Chapter 18: Growth Explained - Incentives Matter, to Everybody
Chapter 19: Debt,Inflation and Deflation
Chapter 20: Stimulus and Budget
Chapter 21: Monetary Policy

Part V: Some Issues in Focus

Chapter 22: Trade, the bankruptcy of comparative advantage
Chapter 23: American Agriculture - Starving the World
Chapter 24: The Economic Imperative of Climate Change

2009-08-30T21:40:00.000-07:00

Chapter 1:

Many Parts

preview of the concepts

the words

This is a book of history, a book of statistics, a book of theory, but at its base it is a book of a few big words.

This is a book of history because economics takes its meaning from its context. Economic and financial institutions are born, developed, reformed, manipulated, and in time they age and die.The economic challenges are not abstract. They the issues of the day. Economic tools have been developed to meet the real world, insofar as they are useful, although sad to say, many tools have been developed at great cost to meet hypothetical worlds. The economics profession is recognized primarily by voices who have risen in one or another order of a priesthood most political and insular. The economics of today is not the economics of fifty years ago nor fifty years hence, but the discussion is conducted as if it is.

This is a book of statistics and case studies because economics ought to be the most practical discipline, concerned with what works and how to get to there from here. While statisticss are often designed to prove the statistician's intent -- designer statistics -- they are evidence and proof if used correctly.

And this is a book of theory, simply because theory is the brain behind economic policy. What works? Why does it work? How does the mind of the aggregate reflect the mind of the individual? How can the whole be made safe and free and fair for its member parts?

But at its base it is a book of a few big words. Some of the words may be familiar, some may not be recognizable. Demand Side. Supply Side. Free-Market Capitalism. Corporate Oligarchy. Conservative or Classical Economics. The Commons. Public Goods.

Demand Side is the biggest word, and it may be the least trafficked. Most will initially understand it as a counter to Supply Side, the economic fad of the Reagan Era that failed so well and continues to fail wherever it is tried. But Demand Side has a longer and more noble history. It began in the 1930s, spearheaded by the greatest economist of the past century John Maynard Keynes. Keynesianism was one of the two major streams that combined to form Demand Side. The other stream arise from the New Deal and its pragmatic combination of social insurance, market regulation and government direction of the economy. The theory and practice of Demand Side were borne out by the Great Depression and the Second World War, as well as by the prosperity and political stability that followed the war, and organized economic thought into the 1970s.

The Demand Side presented here is this combined stream of Keynesian and New Deal thinking as augmented by the work of Leon Keyserling and John Kenneth Galbraith and by Hyman Minsky, Joseph Stiglitz, James K. Galbraith, and George Soros. We add here an emphasis on public goods and the commons.

Demand Side is not a belief system, but a science of economics that has been examined and proven, and continues to prove out.

Supply Side was a short-lived experiment in Pollyanna-ism which proved a failure as an economic school, but lucrative to the political backers of then president Ronald Reagan. Its tenets held that freeing markets from government red tape skewing financial rewards upward would unleash new waves of growth, promises which quickly faded in recession and debt. It was economics, as Thorsten Veblen put it, as "an exercise in ceremonial adequacy." Supply Side is a big word with a small meaning. It was promulgated by the powerful and most often accorded only with the interests of power. Because of its powerful sponsors, it remains alive today in quasi-independent institutions such as the Heritage Foundation and American Enterprise Institute.

Free-Market Capitalism is a big word indeed. It represents an exposition of a concept that a vibrant provisioning of the planet's people is possible based only on the incentives to profit. Its titular prophet was Adam Smith. His Invisible Hand is as close as many economists get to theology. The premise is that if left unfettered by governmental interference, each person and business will by the magic of the market produce what is needed in the optimal amounts by no other compulsion than the great virtue of personal interest.

This is, as John Kenneth Galbraith wrote in his Economics in Perspective, "a celebration of approved belief ... thought founded not on what is actual but on what is agreeable and convenient to the influential interest." As we look at the work of Galbraith, we will see that the market is not free, but controlled and controlled most often by the corporate giants whose existence is assumed away by Free Marketeers. Nor does the optimal complement of goods come into existence, magically or otherwise, but most often only those goods which produce wealth for the wealthy. The product of pollution, global warming, mind-numbing jobs, poverty and ignorance are, in economist-speak "externalities" to this free market. External only to the sacred event of purchase and sale. Free Market Economics is a word as big as Oz.

Corporate Oligarchy. When this term is defined, it will be instantly recognizable. An oligopoly is an economic term referring to the control of a market by a few large firms, the reality of the market as opposed to the free-market fantasy. Oligarchy is the control of the state by a few people. "Corporate Oligarchy" refers to control of the state and the economy by corporate interests: Big Pharma, Auto, Defense, Big Oil, Wall Street. The defining contest of the present day is the competition between representative democracy and Corporate Oligarchy for control of the state.

Conservative or Classical Economics is that primarily academic pursuit which posits long-term stability and functionality absent an overt organizing hand. This is the invisible hand economics. In some ways it is congruent with Free-Market Capitalism. It is to Free Market Capitalism as the Bible is to a religious tract, more complete, but less simplistic, and infinitely more susceptible to interpretation.

Classical Economics took quite a blow from reality with the advent of the Great Depression, made a strong comeback, but is now again in deep defensive mode. It has always been behind the curve. Its purpose seems not so much to assist the survival of the world's civilizations as to provide, in paraphrase of Galbraith the elder, non-offensive employment to professors and instructors. The mathematical exercises of much of Classical Economics relate to historical reality in the same way the reactions in a petri dish refers to evolution. There is a certain similarity in pattern, but the scale and gravity is of a different dimension. Unrealistic, simplistic, myopic assumptions remove findings from the world of relevance to the laboratory of peripheral interest.

The Commons is an elementary economics word which originally referred to pasture held in common by villagers. Today the Commons is rightly seen as the air, the water, ecosystems and resources shared or used in common. The Tragedy of the Commons is the full title for the original observation. Tragedy because inevitably the Commons became overgrazed and barren, for there was no incentive for any one user to show responsibility. If his cow was restrained from the pasture, another's would take its place. So in addition to barren pasture, the Commons produced gaunt and profitless cattle. Overuse of the world's ecosystems and resources will reproduce those outcomes on a planetary scale. Developing the institutions and moral fortitude to take responsibility for the Commons a necessary next step in evolution.

Public Goods are in distinction to private goods. The market produces private goods, individually consumed goods, from candy bars to cars, in abundance. Public Goods are not produced so abundantly. Public Goods are the province of federal, state and local governments. They include roads, police, education, national defense, courts and prisons, some health and social services, libraries, and so on.

Public Goods is a big word because it is by way of Public Goods that prosperity is seeded, nurtured, grown and ripened. The roads, national defense and education systems of the U.S. have been the platform upon which the society has risen. Policy which prefers that private goods dominate is a route not to well-being, but demonstrably, to instability and failure.

This is not a theoretical contest, this contest of theories. There is empirical evidence. We offer some in Chapter [pres] with an examination of economic outcomes by party of the president. Elsewhere [chapters ...] we look at productivity, growth, employment and unemployment, inflation/deflation, markets, specific sectors like Agriculture and Energy. Historically and statistically the economy has done better under the practice of Demand Side Economics. Classical Economics, Free-Market Economics, and their stepchild Supply Side inspire religious devotion, but do not work.

We also look at those issues, obstacles, challenges and threats which society must solve for its own survival and which will need the organization of economics. In large part the critical path is blocked by the entrenched corporate control of the economy and abetted by an economics of confusion. Global climate change, desperate poverty in the Third World, immigration, loss of democratic control of political institutions, inability to adapt, all are connected in an economic context and through economic institutions.

And we offer a way forward. It may be surprising, given the harsh terms employed in the first two parts, that the remedies here are seemingly so mild. One eye has been kept on political practicality, to be sure, because a remedy is no remedy if it cannot be applied. But, for example, the cleansing of the market process from manipulation by corporations ought to be amenable to theoretical Conservatives as well as progressives. It is those who employ the tenets of a free market faith in their sermons, but whose purpose is not to support strong economics, but to excuse corporate control, who will be most exercised. A symbol of this might be that the proposal to free the tax code from purposes ulterior to funding the government, no doubt politically wildly impractical, is probably the least dubious in theory. Elsewhere, the value of public goods is not so much controversial as it is misunderstood. A fair look at public goods and the necessity of maintaining the Commons will lead to approval in most eyes.

This is not a book for economists. Some may see it as a book AGAINST economists. It is instead a book for people concerned with public policy. The minutia and sophistry with which economics is usually occupied are distractions we can no longer afford. Instead we need a lens for penetrating the confusion of competing theories and explanations. Whether or not the reader accepts all the arguments and observations, we hope he or she will admit that at least the scope and perspective is appropriate.

The well-being of the poor and middle class are of infinitely more importance than that of the wealthy, not only because there are more of them, but because when they do better the whole does better. The great nonsense of modern times is that wealthy individuals and countries are so by necessity, to keep some sort of economic machinery running smoothly. Quite the opposite is the case. When well-being is concentrated in a few, imbalances are created that not only produce immoral poverty and deprivation, but that threaten a successful progress into the future. Personal security cannot be the province only of the wealthy, nor can the incentives to do better be confined to the upper quintiles.

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Chapter 2:
Three Challenges

Three Challenges and the demand side approach

There are three major challenges that confront us - the environmental collapse of the planet, global poverty, and the economic decline of the United States. We will explore these throughout the book, but we approach them here because they ought to be the organizing influences of economics. They are the counterpoint to the consumer society, to corporate control and materialism as the primary ethic. - ought to be organizing influences of economics.

The Environment

The deterioration of global ecosystems has been chronicled in a drumbeat of scientific investigations. No longer is it possible for any but the intentionally myopic to avoid seeing the need for concerted action. There will be no escape or substitute for addressing the causes and reversing the symptoms of global warming. Rising sea levels, the deforestation of vast tracts, receding glaciers, stalling sea currents, disappearing phytoplankton, the pitiless march of desertification, each threaten to send the Earth spinning off its climatic axis.

Wider appreciation of the impending calamities is limited by fearful denial and purposeful ignorance. The hesitance of many scientists to be more aggressive in advocacy has not helped, nor has a parallel disinformation campaign waged on behalf of industrial activities which poison the environmental future, but which thrive in the current market. Public policy which condones the current laissez faire scheme or delays aggressive action is denial.

It has been argued specifically that the United States can do nothing about these problems because of the economics. Adaptation and remediation will, it is claimed, be a burden to its industrial base. Demand Side sees the future in a direction 180 degrees from this. We can choose how to employ our resources, labor and capital. We do now by default, or by a corrupt process of "competing constituencies," wherein the representative bodies become marketplaces themselves and results are determined by the highest bidder.Economic life is a matter of human design. Its institutions, incentives and relationships are issues of civilized humankind arranging its provisioning. There is no parallel between this arrangement of human institutions and the natural laws and ecological balances that are now threatened.

The environmentally conservative and productive industries are economically of equal or greater value than those which destroy. The development of new energy systems and the next transportation technologies could drive a vigorous economy. Those whose profit depends on the current technology have stymied research on and deployment of alternatives on the absurd premise that society cannot afford its own survival. It is a tactic entrenched interests have used for centuries.

A demand side economics can order costs and prices in a rational way and generate a truly productive economy. How? By freeing the market mechanism itself from control not by an interfering government, but by dominating corporations.

More specifically, when scientists say climate change is caused by human activity, the "human activity" is the burning of fossil fuels in an amount that creates greenhouse gases - the energy generation for industry, home heating and the animation of hundreds of millions of motor vehicles. The last activity is the most important in the short term, because it is where "human activity" can be altered quickest and to best effect. In the middle term, new energy sources and techniques to conserve energy use must be developed. Long-term survival will require a new development path for nations. We cannot afford what we already see in India, China and others - a desperate rush to development utilizing the same dirty energy technology that has pushed the planet to the brink. China, the new industrial giant, for example, may become the world's first failed state environmentally even as it dominates economically.

World Poverty

Fully three billion inhabitants of our planet, half its population, subsist on less than $2 per day. [FN: Ignacio Ramonet, "The politics of hunger," Le Monddiplomatique, November 1998.]

The World Bank identifies 1.3 billion people living on less than $1 per day. A billion people cannot read or write at even the most rudimentary levels. [The State of the World's Children, 1999, UNICEF.]

The United Nations Millennium Development Goals define a program of rescue, not development. Global health problems, which comprise several of the goals, are more properly problems of poverty, malnutrition and want.[FN: Immigration, an issue which has aroused such fear in the United States, is a function of impoverishment of Mexico and other Latin American countries. This is an economic and trade problem, not an issue of border security.]

At the same time, we engage in a national and regional policy of governmental competition with our trading partners. "Competing" with our "partners" does not raise an eyebrow. The competition is to produce the most for least, and when it infects public policy it means that huge costs are shuffled out of the market and onto the public purse. These are the so-called "externalities" - environmental degradation and human deprivation among them. The Commons is exploited for private gain, and necessary Public Goods go wanting.

Nations should cooperate for the common good. The corporations are those who should compete. Instead, as Stiglitz points out, the world's most powerful nation seeks to dominate the weaker and often for the benefit of major corporate interests. By way of the World Bank and International Monetary Fund (IMF) radical market-driven economic schemes and suffocating budget requirements are prescribed for developing economies. These are strictures we in the U.S., even as conservative as we have become, would never approach in practice and were never seriously considered when economic crisis visited our shores. As we will see, instead of factories and exportable commodities and debt, these nations could be building roads, schools, infrastructure, utilities and reinforcing their basic agrarian economies. They could be building a future not dependent on Western consumerism, but collaborative in a broad prosperity "Globalism" too often means plantationism, more miserable than serfdom because workers do not have the rights even of soil.

The economic decline of the United States

We wrote in the first edition of Demand Side Economics:

"The United States is in advanced stages of losing its manufacturing base. It clings to doomed technologies. Its infrastructure is aging and decrepit. Both government and citizens subsist on debt and borrowing. While the U.S. remains the richest nation, the free market ideology that directs federal policy comes with a curiously contradictory price tag in the form of enormous public borrowing by the Free Marketeers who direct fiscal policy. This borrowing and the resulting debt is then cited as proof of the regrettable profligacy of government.

We have doubled our mortgage debt within the past six years. Our aging population enters retirement with its Social Security made fragile by decades of borrowing to float general government operations. The free market advocates who advocate low taxes and high deficits have hidden from us as much as possible the financial facts. Borrowing does not reduce taxes, only postpones them to be paid back with interest.

Much of our debt is held by foreign central banks or individuals. They have financed our homes and durable goods. They will not be satisfied with payment in currency. Money is simply the medium of exchange. They will want goods and services. What will we give them? Where is the industrial plant or development plan to repay our debts?

Health care demands a sixth of our output, twice the proportion of other industrial nations. War demands people, treasure and effort that cannot be used to address our other problems.

Huge borrowing also bids up the value of the dollar. American-made products priced in expensive dollars must then compete with the manufactures of other countries. Standard economic theory has no explanation for trade deficits of hundreds of billions per year for decades. The inflated dollar and the trade deficit are inextricably linked, and result from the use of the dollar as reserve currency. The implications for with the implications of instability and potentially excruciating correction are enormous if it should return to its role as simply a medium of exchange. Will the Federal Reserve, the central bank of the US, allow the dollar to collapse? Or will it pursue in futility the strength of the currency at the expense of a collapse in the economy?

Meanwhile workers and productive industry absorb the costs. Median incomes have stagnated since 1980, and wages have actually declined in real terms. Health care, energy, housing and education have consumed more of the family's budget. And this richest nation also boasts the greatest disparity between its rich and poor.

There is a way for the US to become a productive power again and for its government and citizens to operate in the black. The country can again trade goods and services in balance, rather than support itself on delusion and borrowing. That way will certainly not be found by running behind the Corporate Oligarchy and hoping for crumbs. The technologies and consumption patterns will not be the same in a rational world, but will provide for a fully engaged workforce and rising global economy that can convert the daunting challenges into opportunities. The United States, or its Corporate Oligarchy, may not dominate others economically, politically, or militarily, but we can be more prosperous, more secure, and allow our planet to survive as home for us all."

These facts have changed but little as of this writing. What has changed is the public exposure to these facts. The struggle between the entrenched interests in finance, manufacturing, health care and energy and the aggressive pursuit of a new, vibrant economy continues.

The economic decline of the United States is now evident beyond contradiction. Later we will address the damage control issues around housing and the debt and insist on measures to ensure that costs and benefits are allocated rationally by the market. We will look directly at the opportunities to build an economy, produce employment, and give ourselves a path to economic prosperity, environmental stability, and global responsibility.

Demand Side Solutions

First of all, it is necessary to employ Demand Side concepts. These are cited and developed throughout the book. They are not startling new ideas to economics, although to many of the economists of the past generation they may seem revolutionary. Demand Side concepts are planted in the fundamentals, experience and practice of the discipline since Keynes.

Output is determined by effective demand. The multiplier validates deficit spending and works best with public investment (public works); less well with tax cuts. Public Goods have real economic and financial benefits that commonly surpass those of private goods, often by factors of two, three, four, or more. And so on.

But adding another layer of economic policy will do little good alone. It is also necessary to cleanse the market of its Supply Side bias. This does not mean excessive regulation of the market participants, but does mean a structuring of the markets and an insistence that the market transaction include all costs, and not advantage the seller in information, nor the private sector by subsidizing demand manipulation.

[bullets?]

The market needs to be transparent and understandable. The exchange between buyer and seller is the only opportunity for accountability in the private market. That is, the products being sold need to be well-defined and homogenous. The buyers' disadvantage with regard to information about products needs to be offset by a public oversight function that ensures safety and freedom from fraud. Costs not included in the purchase price and shunted aside under the rubric "externalities" for other, unnamed actors to deal with, are effectively the proof of market inefficiency. Markets can be well described in terms of products and warantees...

Third, it is necessary to take producers of consumer goods off steroids by eliminating the subsidy to demand manipulation. Advertising, promotion, bribery, lobbying and all such activities that are not directly connected to producing the good or service need not be subsidized. The manipulation of demand is currently deductible from taxes as costs of doing business. This does not mean new regulation. It simply ends the tax deductions that are back door subsidies.

Fourth, it is necessary to offer the developing world an alternative path to development, to invest in their economies not plantations, to remove the unfair and crippling burden of debt from their backs and to reform trade to protect and enhance agrarian economies.

Addressing the challenges in the context of Corporate Oligarchy. It is essential to recognize the true structure of our economy and the dynamics of a Corporate Oligarchy that is the major obstacle and must be a major player in any solution. It is unrealistic to expect corporations to become docile or go away and submit their dominant positions meekly. Politically they are very powerful and have influence in every political forum, and pull with Main Street through their work force. On the other hand, in terms of popularity, corporations are not favorites of citizens. According to polling, most Americans believe corporations have inordinate power.

Where corporate and public interest are directly in opposition, the way forward will of necessity be confrontational. It is no longer affordable to condone a development path determined by whichever market force dominates. In the context of the realities of the new millennium, however, the dominant companies can be invited and enabled to reinvent themselves. New energy sources, reformed transportation systems, low-chemical models for food production, and so on, are Public Goods which the Corporate Oligarchy has eschewed for inability to develop and maintain and control the markets. In some cases, government should guarantee markets - i.e., price and quantity - so corporations can shift from exploitation of their current power to a targeted industrial development and a partnership with the public sector. In other cases, for the public goods, it is the government itself which will be the buyer. The government contract is a clear, reliable description of cash flow that can be expected by a corporation. As Minsky points out, this is exactly and all that is needed to lever private investment in capital. And it is no longer in prospect for the "consumer economy."

This is a practical way forward, completely in line with substantial and stable profits. This must become clear to the corporate princes as well as to the rest of us. But it is a change from the consumer economy. In a public goods recovery, there is no less consumption (in fact, considering their nature, there is more), it is the nature of the goods that changes. Rather than private goods -- consumer goods of all types, from baubles to food and clothing to housing and cars -- it is public goods which are emphasized -- education, public health, infrastructure, climate stability, public security, and so on.

It is a cruel myth that economic activity is orchestrated by natural laws and revolves in a manner to which governmental policy always amounts to interference, a reduction in efficiency, a distortion. Economic affairs have evolved to favor the powerful in every society. When the people are powerful, as in a free democracy, they are favored and the economy does well. When not, financial rewards cant to the dominant institution or group and economies sputter or stall as social tensions rise.

It is, then, not populations that must bow to the natural laws of an economic galaxy. Instead the institutions, rules and incentives of the economic galaxy must be ordered to benefit populations. In our real and present case this may allow the pursuits needed for survival of society.

2009-08-29T10:31:00.000-07:00

Chapter 3
Demand Side Minds: An Overview

"Economics is the religion of the present."
- Thorsten Veblen

Demand Side economics arose from the work of John Maynard Keynes – the most accomplished economist of the last century, John Maynard Keynes. It was part of the practical economic blueprint in the United States through the 1970s. Demand Side theory explains the macroeconomic phenomena in postwar America. This volume outlines Demand Side and extends and illuminates by reference to the work of John Kenneth Galbraith and Joseph E. Stiglitz.

John Maynard Keynes and the Great Depression

Demand Side economics arose during the Great Depression and was ratified by the experience of World War II. Its two major impulses were the work of John Maynard Keynes and that of the New Deal Democrats. The Great Depression, whatever its causes, was a contradiction to the free market capitalism as practiced in the United States and to its Classical apologists. The same contradiction confronts the same Classical Conservative ideology today. The causes of the Depression have been extensively debated, but the contradiction lies not in the advent, but in its lingering and worsening year after year. In Classical theory, a condition such as the Depression could not persist for any meaningful length of time. When the Depression did persist, the response by economists had to be either learning and adaptation or denial. There was no shortage of the latter in academia, but political reality propelled the former to the fore in the arena of government and public policy.

Keynes identified a paucity of effective demand as the cause of the prolonged slump. Economic activity was not returning to adequate levels because there was no force to draw it there. In classical theory, production itself always provided the means to purchase. This was codified in Say's Law. Adherence to Say’s Law prior to Keynes determined whether you were a legitimate economist or a crackpot. Keynes addressed his most stinging critiques to Say's Law and its totemistic Classical followers. There is no automatic stabilizing mechanism to the a market economy, he said.

Simplistically put, if people do not earn an income because there was nobody to buy their goods or services, the appropriate remedy is government-sponsored demand with deficit spending, spending financed not by tax revenue, but by borrowing. This is the nut of Demand Side economics: It is the strength and direction of demand which organizes and energizes a society's economy. (This means effective demand, of course, not simply an intense desire or even need, but a demand with real money behind it.)

Deficit spending recommended itself as well to activist economists in Franklin Roosevelt's New Deal, but not so much as a means of creating effective demand as much as a way of financing the mitigation of the suffering of the unemployed, aged, disabled and impoverished. Programs to help these groups in the absence of an ability by the government to raise sufficient revenue created the deficit spending Keynes prescribed. During the dark years of the 1930s, however, the efforts of the New Deal never reached a scale sufficient to banish all doubts about Demand Side as an economic framework, nor did they completely invigorate the economy. That scale was found in World War II.

The massive government action and mobilization of the economy required by the War washed the Depression away virtually overnight. Domestic living standards actually rose even as the society's treasure poured into munitions, war machinery, massive operations across the globe - in other words, into products and services that were entirely destructive or would eventually be destroyed. In spite of nonproductive, non-consumer goods being produced on a tremendous scale, the economy also produced more consumer goods for the people on the home front.

This organization and mobilization was made possible by Keynes' concepts' opening the way for a statistical definition of the economy. The execution of this definition was pioneered by Simon Kuznets and comes to us in the form of the National Income and Product Accounts.

World War II and its economic organization ratified Keynesianism, and until the middle of the 1970s, public policy was guided by a Demand Side understanding. At the same time the United States was favored in industrial competition by virtue of the destruction of the competing industry of Europe and Japan. The two converged in a broad prosperity that had never before been seen.

Leon Keyserling, the New Deal and the Postwar Prosperity.

quote from Keyserling.

Leion Keyserling is, of the economist featured here, no doubt the least well-known. He came to Washington in the early 1930s to participate in the challenge of the Great Depression along with the best minds of a generation. Keyserling participated in New Deal policy from the outset, being the chief drafter of the Wagner Act in 19xx. He structured the signal piece of eocnomics legislation in American History, the Full Employment Act of 1946. He managed economic policy under Harry Truman, conducting a successful transition from War to peace and setting in place the pillars for postwar prosperiity. And late in life he materially assisted in the Full Employment Act's sequel, the Humphrey-Hawkins Bill.

Keyserling was no doubt the most powerful of all chairs of the President's Council of Economic Advisers. But -- in a comment more telling about its authors than its subject -- many mainstream and academic economists found Keyserling less than qualified for not having completed his PhD. Keyserlling is not just a place holder for the genius of the New Deal. He was a powerful exponent of an economics that worked.

John Kenneth Galbraith and the Rise of the Corporate State

As were Keynes and Keyserling, American economist John Kenneth Galbraith was active in public service and accomplished at its highest levels. Like Keynes, Galbraith was also an influential writer on economics and a noted academic. Canadian born, schooled at Harvard and Berkeley, Galbraith moved into the federal government at the outset of World War II, where he directed the Office of Price Administration, the second most powerful civilian post in the management of the wartime economy. Galbraith was literally controller of prices in the United States, charged with keeping wartime shortages from turning into crippling inflation or spawning debilitating black markets. At the War’s conclusion, Galbraith led the post-mortem survey and analysis of the German war industry and economy. His group reported out a surprising ineptness of the German economic organization and at the same time cast doubt on the effectiveness of Allied bombing. [FN survey]

Under John F. Kennedy, Galbraith served as ambassador to India. Often described as a maverick in his professional work and writing, Galbraith simply examined the affluence and institutional changes that were forming clean of the coloring of self-congratulation. The conceit of Americans for the good times that followed the war was by no means confined to economists, but the prosperity that occasioned it was based less on the imagined American virtues than on the advantage of having an infrastructure intact and an industrial capacity left undamaged, surviving as the sole financial as well as industrial superpower. Later the generation that enjoyed the prosperity and power came to be known as the Greatest Generation, but most credit is due their parents, whose basic talents were pragmatism and an ability to learn from the errors of World War I. This was the generation of Keynes, Keyserling and the elder Galbraith.

Galbraith described the rise of the corporation to dominance, the rise of government as a primary component of and actor in the economy, and the immense explosion of material prosperity that followed the War. Galbraith's writings explored a need for institutional counterweights to the Corporate Oligarchy - unions, governmental oversight, regulations, and social insurance. His foundational book The New Industrial State defined the part of the economy dominated by the large corporations as the Industrial System. This was the chief trait of the new industrial state. While previously corporations had rule industries where scale of operations required bigness, Galbraith saw that they had moved into other parts of the economy as well. The pervasiveness of the corporation iis even more apparent today than when Galbraith wrote in 1967. The New Industrial State dissected the corporate culture, the technical reasons for its arising, the group think which he called the Technostructure, its goals, how it determined prices and controlled markets, and its ever more involved relationship with the state.

This relationship evolved into predation, as Galbraith's son James K. chronacled and explored, of the institutions of the state itself -- particularly those developed in the New Deal. Corporate oligarchs in conspiracy with politicians under a banner of Supply Side anti-regulation exploited privileged and entrenched positions. The younger Galbraith's "predator state" analysis earns him a place in this volume.

Beginning with the administration of Richard Nixon, Demand Side began losing influence. With the ascension of Ronald Reagan, Demand Side was shunted aside as a policy tool. The free market bias that had failed in the Great Depression returned to dominance in policy-making, along with a revival of the Classical justification. Simultaneously and not coincidentally the sturdy growth rate that had trended up more or less steadily from the end of World War II was halved. A similarly stable unemployment rate doubled. The federal debt ballooned. The de-industrialization of America began. Median income stagnated. The disparity between the rich and poor grew. Aside from a respite during the eight-year Clinton Administration, that situation of ballooning debt and underlying economic stagnation continues into the Great Recession.

Hyman Minsky and Economic Instability

Superficially, the Reagan era ushered in the Great Moderation, tepid growth but low inflation. This was taken by the economic establishment to be stability and prosperity. Maverick economist Hyman P. Minsky, a practitioner of legitimate Keynesianism, identified this placid surface as the incubator of instability endogenously produced by capitalism. Minsky published Stabilizing an Unstable Economy in 1986. The subsequent quarter decade produced the object lessons for its accuracy. But even as this present volume is written, the lessons of Minsky are completely unknown by a wide range of policy-makers.

Examples might be:

The direct line from budget deficits to corporate profits;
That money is created not by the central bank, but by financial markets in facilitating investment and borrowing;
Inflation can be useful as a means of escaping economic crises without banking breakdowns.

Joseph E. Stiglitz and Globalization

Not only did the poor get poorer in the United States (in inflation-adjusted, or "real," terms) beginning in the late 1970s, but also around the globe, particularly in Africa and Latin America. Some Asian economies did begin to develop, but others struggled. Remarkable successes were scoored in China, Japan, South Korea, and others. Tragedies have occurred in Africa and Latin America. It was no coincidence that the economic troubles of these countries followed their adoption of the charts of the Free Marketeers. The Neoliberalism (to be defined and developed in Chapter xxxx) that had failed so well within the United States failed even better in these countries. Nations under the sponsorship of the dominant corporations fell extremely hard. This international rise and fall has been the context for the work of Joseph E. Stiglitz on Globalization.

Stiglitz was awarded the Nobel Prize in Economics in 2001 for work which demonstrated the absence of free market efficiency. He won a second Nobel in 2007 as a key member of the Intergovernmental Panel on Climate Change. Like Keynes, Keyserling, and the Galbraiths, Stiglitz contributed significantly in public life as well, serving first as chief economist in the administration of Bill Clinton and later as senior vice president and chief economist to the World Bank. Two of his books Globalization and Its Discontents and Making Globalization Work describe the causes and conditions of developing economies stressed, exploited and then shackled by Western Neoliberal mandates, often through the auspices of the International Monetary Fund and World Bank.

James K Galbraith and the Predator State

James K. Galbraith's work is in some ways an extension of his father's. In many ways it is more explicit and prescriptive. The younger Galbraith was also involved in public service, serving as the executive director of the Congressional Joint Economic Committee and a lead in the drafting of the Humphrey-Hawkins Full Employment Act.

The ascendency of the Reagan Revolution, under the banners of deregulation and market efficiency, the corporate sponsors of neoclassical economics rode into power inside and outside of government. Galbraith and his demand side lineage were pushed to the side. The banks ran the Treasury Department, Health insurers and Big Pharma rode to riches on the health care system, Big Oil wrote the federal energy policy, and so on. This process culminated under George W. Bush. It was dissected and its pathology described by James Galbraith in a piercing tome The Preditor State. Galbraith marked the capture of democratic social institutions and the exploitation of them for private gain. His remains the most coherent and forward-looking macroeconomic perspective extant.

George Soros and the Way Markets Works

The work of these giants of the theory and practice of economics informs the Demand Side economics presented in this volume. Each of them except Minsky has held highly responsible positions in government or the private sector, and all save Keyserling have had notable academic achievements. And each has contributed substantially to the advancement of understanding in the discipline of economics.

2009-08-28T08:56:00.000-07:00

Chapter 4:

John Maynard Keynes and the Great Depression

"Capitalism is the astounding belief that the most wickedest of men will do the most wickedest of things for the greatest good of everyone."

- John Maynard Keynes

Bio

Historical Context within the profession

The Primacy of Demand

Economics occurs in historical context. The Great Depression was the context of British economist John Maynard Keynes' identification of the primacy of demand, the originating point of Demand Side.

Keynes influence preceded the Depression. As a young man he participated in the negotiations closing World War I. His acerbic Economic Consequences of the Peace, published in 1920, gained widespread attention immediately after the Treaty of Versailles. Over the next decade and a half Keynes analysis of the consequences of the terms imposed on Germany proved accurate. He predicted the desperate economic vise and the consequent social disruption which gave rise to Hitler and the Third Reich.

To the popular mind and to many of the intelligent and educated, the Great Depression seemed to be the end of the Capitalist experiment. The successful economies of the 1930s were those of Nazi Germany and Stalinist Russia. A choice seemed to be indicated between one of those two systems.

The standard economics of the time did not, as surprising as it may seem, include the possibility of, nor an explanation for, the massive unemployment and industrial stagnation the US entered in 1929. Previous crises were seen as minor corrections in a long-term stable state. When the Depression began, as it worsened, and as it lingered, the predominant advice of economists was, "Patience. Stay the course."

In economic circles, this condition of perpetual denial was founded on Say's law, the proposition that production itself, by its payments to labor and capital, created enough demand to purchase production. Adherence to Say's Law was virtually a litmus test for consideration as a serious economist.

Keynes saw the problem of the Depression as not enough demand. Farmers produced milk but dumped it in the street for want of buyers at a reasonable price. As prices crumbled, incomes crumbled, people hoarded against expected want, demand receded further, and the cycle went around again.

Keynes saw that adequate effective demand could return the economy to full employment of its labor and capital. Demand could create production, but production did not necessarily create demand.

The "liquidity trap" Keynes postulated arose when people preferred hoarding cash to investing or purchasing. When inflation turned to deflation, in fact, hoarding was a financially sound practice. Cash became an investment in itself, since it became more valuable over time. The cruel reality, however, was that savings in the absence of income sooner or later went for necessities.

The Multiplier

In concert with its originator R.F. Kahn, Keynes also developed and promoted the multiplier. Investment or government expenditure creates an economic surge as it echoes through the economy. The producer of one good is the consumer of another as his good is sold and he spends his income. Thus, money can be followed from hand to hand as it facilitates the exchange of goods and services. The same money buys shoes from the shoemaker as buys bread from the baker as buys meat from the butcher, but the consumer changes from shoemaker to baker to butcher. If the money stops - as above - in one or another's cookie jar, the sequence of purchases and sales is interrupted and the employment of people and facilities down the line never occurs. The economic activity is stopped by the act of hoarding.

The corollary to this sequence is Kahn's multiplier. Any particular amount of government spending or private investment will create multiples of that amount in economic activity, as the first new income is passed from consumer to producer, who then becomes the next consumer. The multiplier describes how much more activity will be created. It is the multiple of investment or government deficit spending in real increased economic activity.

Different economic actors will affect the multiplier differently. As the money passes through a poor person, for example, it will likely survive intact as a purchase of a good or service because a poor person tends to spend all of his or her income. Similarly, payments that go through government accounts tend to employ people and survive as demand for the subsequent services, because government is not in the business of saving. In contrast, payments to the wealthy are not so readily turned over. The tendency to save or spend in a manner which is tangential to the main economic life of the society is much greater among the wealthy. A full exploration of the multiplier and the factors that act to reduce it is presented in a later chapter.

Today the multiplier survives primarily to describe the stimulus value of government deficits and to offer an inappropriate justification for all tax cuts. Keynes himself preferred direct employment through public works. As all reliable economics texts will attest, direct government spending is undoubtedly greater stimulus than tax cuts, since the first round of leakage from private spending is absent in government spending. Tax cuts balanced by spending reductions are undoubtedly contractionary, for the same reason. Tax cuts funded by deficits is absurd economically, as it means revenue formerly generated in taxes is now being borrowed. Yet this is precisely the policy of the current Bush administration. The same revenue thus comes with the cost of interest attached.

Tax cuts also produce on the margin of personal demand. The "margin" refers to the last increment. Marginal income tax rates, for example, refer to income above a certain level. Income below that level is taxed at a lower rate. In the case of tax cuts, the money freed up to individuals and households would be spent on items less essential than the first dollars of income. Thus tax cuts produce more discretionary goods and services than direct employment from public works - more deodorant and cell phones and fewer houses. Public works employ people directly and distribute demand across the full spectrum of household needs.

Casino Markets
http://johnquiggin.com/index.php/archives/2009/07/13/keynes-and-the-casino/

Dead Ideas from Live Economists: The Efficient Markets Hypothesis

When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done, JM Keynes, General Theory of Employment, Interest and Money Ch 12, p142 in Google Book edition, Atlantic Publishers

If there is one economic doctrine that has been central to thinking about economic and social policy over the last three decades, it is the Efficient Markets Hypothesis, or more properly, the efficient financial markets hypothesis. The EMH says that financial markets are the best possible guide to the value of economic assets and therefore to decisions about investment and production.
Although economists since Adam Smith have pointed out the virtues of markets in general, the EMH with its focus on financial markets is specific to the era of finance-driven capitalism that emerged from the breakdown of the Keynesian Bretton Woods system in the 1970s. The EMH justified, and indeed demanded, financial deregulation, the removal of controls on international capital flows and the massive expansion of the financial sector that ultimately produced the greatest financial crisis in history.

Some more linking material to come here
Keynes and the casino

Few economists have been successful investors, and quite a few have been disastrous failures. But after a narrow escape from disaster early in his investing career John Maynard Keynes made a fortune for his Cambridge college by speculating in futures markets It is a striking paradox that Keynes was among the most scathing of all economists in his assessment of the role of financial markets.

“Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done” (General Theory Ch 12, p142 in Google Book edition, Atlantic Publishers

During the decades of the long Keynesian boom, financial markets were tightly regulated, and, as a result, financial crises disappeared almost entirely from the experience and memory of the developed world. At the margin, substantial profits could be made by finding ways to work around the regulations, while relying on governments to maintain the stability of the system as a whole. Not surprisingly, there was a warm reception for theoretical arguments that presented a more favorable view of financial markets.

Keynes’ views were reflected in the systems of financial regulation adopted as governments sought to rebuild national economies and the global economic system in the wake of World War II. The international negotiations undertaken at a meeting in Bretton Woods, New Hampshire, in 1944, where Keynes represented the British government, established an international framework in which exchange rates were fixed and movements of capital tightly controlled.

National governments similarly adopted policies of stringent financial regulation, and established a range of publicly-owned financial institutions in response to the failures of the private market. In the United States, a host of regulatory bodies were established to control financial institutions. The Glass-Steagall Act established the Federal Deposit Insurance Corporation (FDIC) and prohibited bank holding company from owning other financial companies. The Federal National Mortgage Association (later quasi-privatised as Fannie Mae, and then renationalised during the early stages of the 2008 meltdown) was established to support the mortgage market.

Although the details of intervention varied from country to country, the effect was the same everywhere. Banking in the 1950s and 1960s was a dull but secure business, resembling a public utility in many respects. Parents scarred by the Depression urged their children to look for ‘a nice safe job in a bank’.

The Efficient Markets Hypothesis changed all that.

It was not Keynesian economics and employment policies that ended the Great Depression, but rather the advent of World War II. The War validated the Keynesian prescription as massive government expenditures and the employment of millions in the military and millions more in munitions and support supercharged the economy. The unprecedented output may have been dedicated to the nonproductive activity of war, but standards of living actually increased domestically across the board during the War. People ate better, dressed better and lived better in the United States during the War than they had in the years prior. At the same time they generated the tremendous product the War consumed.

In the next chapter we explore what happened when peace resumed. It is worth noting that the transition from a war economy to a peace economy began with a Keynesian commitment to full employment, the Full Employment Act of 1946. This recognized the power of government to produce economic outcomes - unthinkable a few years earlier. The economics propounded by Keynes worked. It was not a challenge to market capitalism, but a necessary adjustment. It is a lesson we need to learn again. Absent another adjustment to market capitalism, the society will fail.

2009-08-22T09:27:00.000-07:00

Chapter 5:

Leon Keyserling and the Prosperity of Postwar America

Bio
Context
The New Deal
The postwar partnership between business, labor, government
The employment act of 1946

LEON HIRSCH KEYSERLING---STILL A MAN FOR OUR TIMES!

W. ROBERT BRAZELTON, PHD.

Preliminary: Not for general distribution.

Leon H. Keyserling had a primary goal in terms of economic policy—constant, full employment/output growth. This appeared in his writings, his critiques before numerous Congressional Committees from the 1930’s , the 1940’s until his death in 1987; and as Chairman of the Council of Economic Advisors to President Truman, 1949-53. Before Keyserling had been responsible for the New Deal/Fair Deal Legislation as a principle author of several important Congressional Bills/Acts, such as: the Public Works Act of Senator Robert Wagner (D, NY) with whom Keyserling was closely connected; The National Industrial Recovery Act, 1935; The National Labor Relations Act( The Wagner Act), 1935; U.S. Housing Acts—an important part of Keyserling’s policies for full employment, countercyclical policy, and decent housing, 1937 and afterwards; The Employment Act of 1946: General Housing Act of 1949, Full Employment and Balanced Growth Act ( The Humphrey-Hawkins Act), 1977 and others (Brazelton, 2001, p. 160).

Keyserling received his primary economics at Columbia University of New York City under the Institutionalist, Rexford Guy Tugwell both as an undergraduate and, after his Law Degree for Harvard University( 1931), as a doctoral student having returned to Columbia. Having been taken to Washington , D.C. by Tugwell and Senator Wagner after the inauguration of President Franklin Roosevelt (1933), he did not finish his doctoral dissertation, but considered the Congressional Acts mentioned above primarily or partly written by him to be of, at least, an equivalent. As a student of Tugwell, he was a liberal with both influences from the Institutionalists and Keynes and, as Lynn Turgeon writes (Turgeon, 1987) was pragmatic in is views, but, to me, within a largely Institutional/Keynesian framework (Brazelton, 2001,2005, 2006). Also, as a member of the Council of Economic Advisors, 1946-49, and its Chair, 1949-52, he developed what was to referred to later as the “Full Employment Budget” under Walter Heller in the Kennedy-Johnson Administrations (Brazelton, 2003; Pechman and Simler, especially the chapter by Walter Heller therein). As such, his constant concentration was upon full employment and full output secularly and cyclically—even during periods of inflation (Brazelton, 1997, 2001, 2005). As I have covered these points elsewhere, I will herein concentrate upon his full employment beliefs to indicate his early stress upon the concept of economic (f9scal) policy and its relevance for us today---still a man for our times!

Full employment meant to Keyserling a constant goal for both secular and cyclical economic policy. Secular referred to his constant growth policies for constant, full employment growth such as in the Full Employment Budget Concept; and his cyclical policy meant that even in an inflation, he would not first stress restricting demand but, rather increasing supply as the cause of inflation was to him primarily inadequate demand, not excess demand! Thus, increase supply in the economy where needed via selective economic policies aimed at the lagging sectors—micro and macro. This related to his concept of “economic balance” where supply growth must equal demand growth, both micro and macro. To increase supply in an inflation, one needed selective incentives. But to decrease demand in an inflation would, to him, not end inflation, but create more due to administered pricing, high interest rates, and in cutting output forcing companies to operate to the left of minimum average costs—all inflationary. Indeed administered pricing, was a major result of inflationary pressures and of imperfect market structures which Keyserling accepted as reality (Brazelton, 1997, 2001, 2005), as can be seen in his publications of the Conference on Economic Progress (see Appendix); and the early development of the “Full Employment Budget Concept”—his “Freedom Budget” or “Nation’s Economic Budget”, etc. (Brazelton, 2001,2003). To Keyserling, full employment growth meant a constant emphasis upon full employment/output. This can be seen from a selection of pertinent quotes; and from a sixteen point program for constant growth and employment (Keyserling, 1975). To quote:

“Maximum employment means full-time jobs for all willing and able to work, allowing for minimum or “frictional “ unemployment, with growth in the number seeking employment not inhibited by scarce job opportunity. It means programs to qualify for employment those now handicapped by inadequate education or training, or debilitated by bad housing and inadequate health care. It means also that those on the job should not be underutilized, and should have a chance to upgrade their skills and earning power. By definition, maximum employment is incompatible with unemployment—or inferior employment or pay—based upon discrimination due to color, race, or sex” (Keyserling, 1964, pp. 87f).

And

“Under the Employment Act, full employment means more than jobs. It means full employment of our natural resources, our technology and science, our farms and factories, our business brains, and our labor skills…Full employment means maximum opportunity under the American system of responsible freedom…and a concept which must grow as our capabilities grow” (Keyserling, 1975,p. 7).

It should be noted that in the above Keyserling stresses economic balance (“…a concept which must grow as our capabilities grow”); and the growth of jobs and income as, to him, the relations between jobs and adequate income are crucial. The growth of output must be offset by the growth of demand (micro/macro). Thus, to Keyserling if C=f(Y), and Y=f(wages), then Y=f(wages) so that to take goods off the growing market (supply—micro/macro, then wages and other forms of demand must grow as well—micro/macro.

That is the essence of long term growth, stability and social justice (Keyserling 1975: Brazelton, 1997, 2001,2003, 2005). Thus, the sixteen points.

In his Conference on Economic Progress Report “Full Employment Without Inflation, 1975 (pp. 34-44), Keyserling argues for a sixteen point program shich I will indicate below and elucidate upon when I consider relevant to the problem of employment introduces by the preceding analysis by Professor Henry. In this paper I will deal with those points which specifically deal with the problem of “employment”, a subject raised by this session. I will number to points as they are numbered by Keyserling and comment upon them in analytic terms.

1. The need for consistent long-term goals

a. Keyserling’s point here was that too much time is spent on short-term analysis and forecasting, not enough on long-term constant full employment/output growth.

2. Growth analysis is an essential, constant goal, but needs as awareness of high

Priorities such as housing, education, health, environment and other shortages.

3. Goals to overcome shortages: The Key Role of Housing

Housing increased the quality of life, but also gave employment to many skilled and unskilled; and increased output/employment in related industries such as furnishings, utilities, roads, etc.---a multiplier effect.

4. Public employment—a permanent public service employment for “eligibles not employed elsewhere” which would serve about one million people (his estimate) and similar to propositions such as the Center for Full Employment and Price Stability (C-FEPS) at the University of Missouri- Kansas City, Department of Economics.

5. A new monetary policy to lower interest rates for investment, housing; and to reduce (or end) the independence of the Federal Reserve (yes, controversial) to make monetary policy “…in accord with the real economic growth needs required to restore maximum employment and production…” (Keyserling, 1975, p.34). The same must be true for fiscal expenditures via the multiplier effect.

8. Balance the Federal Budget, but, first, get out of recessionary conditions and lance only after “…restoration of a fully-rised economy (Keyserling, 1975. p. 38; Brazelton, 2005; Pechman and Simler, 1987).

10. Income supports would be to restore full employment equilibrium and in terms of needed “social insurance” such as unemployment compensation, etc.

11. In terms of the above (10) substitute the “…ragbag or costly and grossly inadequate ‘welfare’ programs …” with “..limited universal income supports…” (Keyserling, 1975, p.40).

13. A manpower to train and retrain workers in regard to the needs of full employment and national priorities and shortages.

The above selected, employment related sections of Keyserling’s sixteen

Points are all basically for the purpose of establishing a full employment/output growth economy constantly. This is obvious in terms of its income/employment suggestions (aggregate demand) and its output stress (aggregate supply) where on both the micro and the macro level, the growth of both must be equal for full employment, price stable growth in the long-run. Also, in Keyserling’s stress against administered pricing, we see a stress upon output in real terms, not merely monetary terms—the former increasing output, the latter limiting real output in favor of price increases and inflation via said administered pricing. These are, of course, still the needs of our times as they were the needs of Keyserling’s times---the fulfillment of national priorities and shortages; maximum output/employment; the control of inflation including administered pricing; the training of an adequate labor force; and environmental, health, income support and energy needs met and reformed. Thus, Keyserling is “Still a Man For Our Times”—or, perhaps, for the future as we have never reached the goals set forth by Keyserling decades ago. That is our failure, not his!

Bibliography

Brazelton, W. Robert (1997), “Retrospectives: The Economics of Leon H. Keyserling”,

Journal of Economic Issues, 11 (4), pp. 189-97.

Brazetlon, W. Robert, (2001), Designing US Economic Policy: An Analytical Biography or Leon H. Keyserling, London, Palgrave Press.

Brazelton, W. Robert, (2003), “The Council of Economic Advisors and the ‘Full Employment Budget Concept’ : Keyserling Before Heller”. Journal of Economics , xxix (2), pp. 87-102.

Brazelton, W.Robert, (2005), “Oral Interview with Leon H. Keyserling”, Research Paper Report, Vol . 2, pp. 377-445. On deposit at the Truman Memorial (Presidential ) Library, Independence, Missouri, USA; and the University of Missouri-Kansas City Library and Archives.

Keyserling, Leon H. (1964), Progress and Poverty, Conferences on Economic Progress, Washington, D.C. , pp. 87f (see, also, appendix hereto).

Keyserling, Leon H. (1975), Full Employment Without Inflation, Conference on Economic Progress, Washington, D.C.( see appendix hereto).

Pechman, Joseph and Simler, N.J. ,(1982), Economics in the Public Service: Papers in Honor of Walter Heller( especially chapter by Walter Heller), Norton Press, New York.

Turgeon, Lynn (1987), Leon H. Keyserling, The New Palgrave Dictionary in Economics, John Eatwell, Murray Milgate, Peter Newman, (eds), Vol. III, Macmillan Press,

New York.

Appendix

The following are pamphlets edited by Leo H. Keyserling and his wife, Mary Dublin Keyserling, an economist in her own right, via the Conference on Economic Progress, 1954-83. They are deposited at the Truman Memorial (Presidential) Library, Independence, Missouri, USA and are crucial in terms of research in this area and era of economic policy and analysis.

CONFERENCE ON ECONOMIC PROGRESS REPORTS:

Toward Full Employment and Full Production, 1954

National Prosperity Program for 1955, 1955

Full Prosperity for Agriculture, 1955

The Gaps in Our Prosperity, 1956

Consumption—Key to Full Employment, 1957

Wages and the Public Interest, 1958

The “Recession”—Cause and Cure, 1958

Toward A New Farm Program, 1958

Inflation—Cause and Cure, 1959

The Federal Budget and “The General Welfare”, 1959

Tight Money and Rising Interest Rate, 1960

Food and Freedom.1960

Jobs and Growth, 1961

Poverty and Deprivation in the U.S.,1962

Key Policies for Full Employment, 1962

Taxes and the Public Interest, 1963

The Top-Priority Programs to Reduce Unemployment, 1963

The Toll of Rising Interest Rates, 1964

Agriculture and the Public Interest, 1965

The Role of Wages in a Great Society, 1966

A “Freedom Budget” for all Americans, 1966

Goals for Teachers’ Salaries in our Public Schools, 1967

Achieving Nationwide Educational Excellence, 1968

Taxation of Whom and for What, 1969

Growth with Less Inflation or More Inflation Without Growth, 1971

The Scarcity School of Economics, 1973

Full Employment Without Inflation, 1975

Towards Full Employment Within Three Years, 1976

The Humphrey-Hawkins Bill “Full Employment and Balanced

Growth Act of 1977, 1978

Goals for Employment and How to Achieve Them Under the “Full Employment

And Balanced Growth Act of 1977, 1978

“Liberal” and “Conservative” National Economic Policies

And Their Consequences, 1919-1979, 1979

Money, Credit and Interest Rates: Their Gross Mismanagement by the Federal

Reserve System, 1980.

How to Cut Unemployment to Four Percent and End Inflation

And Deficits by 1987, 1983

2009-08-21T09:21:00.000-07:00

Chapter 6:
John Kenneth Galbraith and the Rise of the Industrial State

"It is not the quantity of goods that matters, but the quality of life."
JKG

Bio
Context
The rise of the corporation and technostructure
The manipulation of demand and conventional wisdom
Who controls production

Who controls production?

The beauty of a market economy, a Demand Side economy, can be that the choices of individuals select the products and goods that are produced. A command economy, such as that of the former Soviet Union, must make production decisions bureaucratically. But having a market economy does not mean having a Demand Side economy. The American market economy is dominated by producers. This is no accident. Production entails plant, equipment, technology investment and distribution channels which involve immense planning, coordination and control. It is precisely the scale of this effort that leads the corporation to attempt to control demand with advertising and promotion and political influence. Still, the result or corporate influences on demand is an absurd abundance of trivial personal consumption items and a paucity of essential Public Goods. John Kenneth Galbraith described this in acute detail forty years ago, and we visit his work in Chapter 5.

With the immense challenges that confront the present society, it is no longer sufficient to produce randomly, oblivious to what goods may comprise that product, satisfied that the total increases and large unemployment is avoided. Specific remedies are needed for environmental degradation and for economic privation both now and clearly visible out the windshield. These will not be produced if we simply trust the vagaries of the market. Goods of quantity and scale and technology far beyond that now being produced are required almost immediately. Whole new industries must be up and running soon.

An economy dominated by producers cannot change or focus in a sufficiently forward-looking manner. The incentives are strong for dominant corporations to produce private goods for which plant, equipment, technology and markets currently exist, manipulating demand to these ends. Thus we have a cacophony of private items stored in houses at the end of broken streets.

Does this mean a necessary compromise with a bureaucratic command economy? No. Demand Side as envisioned here does not require an immense explosion of government to produce or demand the needed new products and processes. It is sufficient to simply remove the Supply Side bias from the market, the implicit subsidies, particularly those implied by so-called "externalities." It is no exaggeration to the say that the market of today's economists begins and ends with the purchase-sale transaction. Externalities - the pollution, social stress, etc. - of production and consumption are "external" only to this purchase-sale event. Production of a car may involve enormous preparation and production before the event. Its use may extend many years after the event. But the market is closed once the transaction has been made. The use or outcomes of use become somebody else's costs. Only by bringing all costs and preferences into the event of sale can the market internalize them and so function rationally.

Demand Side components of price do not need to go through the government. Private accounts will do. In the example of gasoline, the cost of its enormous externalities can be transmitted to other private companies who are willing and able to engage in mitigation activities or in developing and implementing the replacement technologies.

That is, the effects of pollution, road construction and maintenance, traffic control and policing, the costs of accidents, as well as the geopolitical maneuvers made on behalf of supply, could be calculated with some degree of accuracy and applied to the price of a gallon of gasoline. This is already done with respect to road construction; typically gas taxes are dedicated sources for building roads. The resulting price of gasoline would then approximate its true cost. This allows the market to function rationally, allocating the product on the basis of real costs. It does not matter whether mitigation is undertaken by private companies directly funded by the gasoline fees or as is more likely be private companies under contract to the government. The price of gasoline would be paying the full costs of the use of gasoline. It is no accident that the appropriate price would reduce consumption. The current price, after all, is essentially subsidized by government and by future generations who will absorb the costs. A price which factored in the externalities would be much higher.

Throughout the Twentieth Century and into today the doctrine of the free market and its unerring invisible hand has been poised over the government and the public. Business groups and corporate boards are a fountain of confidence in the mind of the market. Doubtless some would be surprised to be told that Adam Smith, the coiner of the "invisible hand," looked unfavorably upon the business associations who promote his metaphor in their lobbying. "People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices." Smith referred to the form of enterprise known now as the corporation and then as the joint stock company and now as the corporation as "useless" and opined that "negligence and profusion ... must always prevail, more or less, in the management of the affairs of such a company."

Consternation would likely be dismissed by a few words on circumstances and complexities of a modern society that have made Smith's simplistic attitude toward business collusion in need of amendment (or in this case, complete reversal) even as the idea of the invisible hand needs no revision. Similar revisions have been made to canons across time. Unfortunately the invisible hand is invisible because it is nonexistent. Production and supply are provided by at most a few corporations, and demand is controlled from the mind of the consumer to the franchised seller. The "free" in free market refers today to freedom for business from government interference and public oversight.

The most direct look at the structure and motivation of industry in the postwar economy was taken by John Kenneth Galbraith. Canadian born, but raised at Harvard, Galbraith, like Keynes, served in several responsible positions in the government over an extended period of time. During World War II he was director of the key Office of Price Administration and assigned the task of keeping the nation's wartime shortages from leading to price gouging or inflation. He then managed the post-mortem survey of Germany to assess the causes and conditions which led to its defeat. His briefing documents offer rare insight into some of the less than epic causes for the demise of the Third Reich.   Galbraith was active in the political campaigns of Adlai Stevenson and John F. Kennedy, to whom he was a close advisor, and he served as ambassador to India under Kennedy.

Where Adam Smith's look at the economy of his time revealed a competitive marketplace which determined price and output, income and investment, Galbraith's view two hundred years later presented something quite different. If only by three relatively straightforward and easily confirmed postulates, Galbraith has subverted the entire foundation of the Classical or free-market paradigm.

(1)    Income is a function of power, not value.

(2)    Corporations are run for the benefit of their managers, not the stockholders.

(3)    The contest between the corporation and the people through the state is the defining contest.

That these observations are not more universally accepted and applied in economics is testament to the need for modern economists to be convenient to the powerful. In three volumes - The Affluent Society, The New Industrial State, and Economics and the Public Purpose - Galbraith consolidated his direct view and his alternative.   He saw that corporate control of economic activity had spread from the major industries it had controlled at the opening of the Twentieth Century - railroading, steelmaking, petroleum, etc., where scale required bigness, to all corners of the society, from groceries to newspapers and media. The ownership of corporations, Galbraith saw, had been transferred from strong personalities at the helms of businesses they had made - the Rockefellers and Carnegies - to anonymous stockholders.

The corporation itself is not ruled for profit maximization to benefit its owners, Galbraith says, but became the tool of its managers, and is run for their purposes, whether pecuniary or simply prestige. Stockholders are needed only insofar as they can be persuaded to bid up the share price and thus the rationale for further escalation of payments to the corporate officers.

     "... the stockholder ... is a passive and functionless figure, remarkable only in his capacity to share, without effort or even without appreciable risk, in the gains from the growth by which the technostructure measures its success."

Rather than being determined by supply and demand, price is determined by the oligopoly, the "big business" responsible for the preponderance of economic activity, acting sometimes as a monopoly and other times in other characters.   But the product of the society, rather than being rationally determined by need was determined to a large extent by the manipulation and persuasion of the corporation. This was in no small way a function of the affluence of the post-war years. As Galbraith said, "No hungry man who is also sober can be persuaded to use his last dollar for anything but food," but in evenly modestly more affluent conditions consumers' "economic behavior becomes in some measure malleable."   And so arose the industries of persuasion, advertising, promotion and manipulation of the political process. At its end,

     "The initiative in deciding what is to be produced comes not from the sovereign consumer who, through the market, issues the instructions that bend the productive mechanism to his ultimate will. Rather it comes from the great producing organization which reaches forward to control the markets that it is presumed to serve and, beyond, to bend the customer to its needs. And, in so doing, it deeply influences his values and beliefs."

Writing in 1967, Galbraith noted that some sectors have not come under corporate dominance.

     "Agriculture, truck mines, painting, musical composition, much writing, the professions, some vice, handicrafts, some retail trade and a large number of repairing, cleaning, refurbishing, cosmetic and other household and personal services are still in the province of the individual proprietor. Capital, advanced technology, complex organization, and the other hallmarks of what we have come ... to consider modern enterprise are limited or absent."

Oligopoly is defined as the domination of a market by a few large firms. Oligopolies directly account for the majority of private economic activity and the overwhelming preponderance of activity indirectly. The economic treatment of oligopoly differs from the Corporate Oligarchy that is one of our "big words" the way a football game differs from live fire combat. The Corporate Oligarchy may employ strategies familiar to football, but it does not play within the lines or stop at controlling the market. Corporate Oligarchy seeks to define and form the market, for example, by making it as big as possible by shifting costs to the public and demand away from public goods. The Corporate Oligarchy seeks to control the context of its market by controlling its regulators and buying its legislative oversight. Thus, while there may be competition within a market between members of the oligopoly, there is only concerted unified action with respect to the wider society within which the market exists.

The implications of an economy dominated by large corporations run for the benefit of their managers are many. Predicating them all, however, is that income is distributed by the measure of power, not by the value or utility of one's contribution. Pricing power itself is more a function of an imperfect market than a perfect one. It is by positioning one's product or service in a unique niche that one is able to extract the maximum price. This is most often done by monopoly - either legal, as arising from patents and copyrights, or less than legal, as arising from intimidating, coopting, or pricing one's competition out of the market.

Economists make a distinction between monopolistic competition - this effort to offer products that are in some way unique though often similar to others - and oligopoly. That distinction, however valid in the context of market behavior, dissolves when the perspective is expanded with the concept of the Corporate Oligarchy.

It is not that the large corporations dominate their niche and then become the big players in the game. It is that the dominant corporations control and define the game, change its rules, own the judges and referees and persuade the populace that the game is a route to happiness when it may be easily be demonstrated to be more a distraction from essential tasks. Corporate Oligarchy is literally a description of the organization of the society, comparable to Representative Democracy, Social Democracy, or Military Dictatorship.

We suspect that this view of the economy is much less controversial among lay readers than it will be to economists. As the chapter on the tenets of Neoliberalism describes, orthodox economic theory often manages the remarkable intellectual achievement of ignoring the corporation entirely.

The corporation itself is immortal and if successful will outlive all its owners and managers. But while an immortal human being might make some accommodation for the future, knowing that he will have to live there, the mind of the corporation - its managers - do not. They are increasingly driven by short-term interests: price-earnings ratios, options prices, and so on. Investment and potential long-term liability are discounted to maximize the short-term profits.

Engaging in labor agreements with pension promises that are not met is one recent example of shot-term bias.    The most dangerous example is likely the willingness to exploit the environment. Combined with the capture of regulatory authorities, one is reminded of the willingness of tobacco companies to engage in the addiction of millions. In the current case, however, the smoker is the planet itself.

The mammoth machine of the corporation is used for the benefit of a few, but this is not regarded as a disadvantage. In fact, the reward to CEOs is evidence to some that they must be doing a good job. Comparing the performance of owner-dominated or closely held companies with those controlled by diffuse stockholders, one does not find the reward justified by the performance.

Compensation for corporate U.S. CEOs at the top 200 companies is 2.5 times that of their European colleagues, or $11.3 million vs. $4.3 million. For those in the next tier, American CEOs made twice the level of Europeans in similar positions, and four times that of comparable Japanese ($2.16 million, $1.2 million and $543,000 respectively, on average). The average CEO of an S&P 500 company made 411 times the average worker's wage in 2005.

Paradoxically the short-term focus of corporate managers retards the evolution of industry, and adaptation to changing circumstances. Maximizing the short term is accomplished by emphasizing present power and present advantages in capital and arrangement of markets, and so creates momentum along the present path. It may be true that innovating the next techno-gadget or the next drug will make its originator wealthy, but if Public Goods or actual reductions in consumption are the route to society's survival, the incentives are sadly misplaced. Energy, Pharmaceuticals, Manufacturing and Banking - capitals indicating their institutional presence - strive to maintain a status quo that amounts to a course toward destruction.

The State

Writing in 1967, Galbraith saw a convergence of the two dominant economic systems - the command economies of the Soviet Union and the industrial system of the West. "The convergence between the two ostensibly different industrial systems occurs at all fundamental points." The state is necessary to the capitalist industrial system to provide adequate demand and smooth prices, he thought.
     "The industrial system has no inherent capacity for regulating total demand - for insuring a supply of purchasing power sufficient to acquire what it produces. So it relies on the state for this. At full employment there is no mechanism for holding prices and wages stable."

And organizational autonomy was essential to communist industries to be efficient.

     "Large-scale organization also requires autonomy. ... Large and complex organizations can use diverse knowledge and talent and thus function effectively only if under their own authority."

As we noted in passing in Chapter 3 and will visit again in the next chapter, this convergence ended badly for the Soviet nations when they overshot, as free-market "shock therapy" administered as a stimulant created instead Depression and Corporate Oligarchy worse than any in the West. ("Only the innocent reformer and the obtuse conservative imagine the state to be an instrument of change apart from the interests and aspirations of those who comprise it," wrote Galbraith in The New Industrial State.)

The state may not be the "executive committee" for the capitalist class, s Marxists contend, but the state - particularly in the United States - is heavily influenced by the corporation. To say that we live in a Corporate Oligarchy means that the corporation has dominant influence over the state, not that the state and its apparatus have been completely subsumed. Industry lobbyists and interest groups exert influence far beyond their numbers. Particularly under Republican regimes, but also under Democrats, the agencies that were assigned oversight have become captive to the industries they are supposed to monitor and control. Officials routinely move from government to the private industry they regulated and back again. Notice in particular, that the most powerful of independent government agencies, the Federal Reserve Board, the central bank, has become captive to financial interests and regulates the economy with primary concern for inflation, which is benign to many parts of the economy, but not banking.

Emblematic of the recent corporatizing of government was the Enron debacle, in which the dominant energy corporations wrote in complicity with the vice president an energy policy that was adopted by the administration of Bush II and within a few years led to market manipulation, fraud, and enormous costs to states and individuals across the country. When a Medicare drug bill became inevitable, vigorous dispute within the legislative branch (indicating the state is not completely coopted) eventually resolved in favor of the interests of the Insurance oligopoly. Rail, the only alternative to the present gasoline-based highway system, is impossible because the technology and infrastructure is under control of the Corporate Oligarchy.

Galbraith made much of the relationship of the corporation to the state, not limited to the manipulation of the political process and apparatus. He observed the exaggeration of the importance of industries in which the state guarantees demand - notably national defense and security. The technological sophistication developed by way of the military industrial complex is astounding. Its efficacy on the battlefield is unparalleled, but its usefulness in achieving political ends is not impressive.

In Galbraith's terms, the industrial corporation is motivated (and even required for the sake of its own survival) to manipulate as much as possible. The immense magnitude of investment and capital and time required to develop and implement a technology imply a similar magnitude of loss in failure. One answer is to arrange for the state absorb this enormous risk, as it does with military hardware.

Corporations are massive, technologically adept, specialized, organized structures. Their ability to organize on a large scale over an extended time period and deliver complex products means that corporations are potentially the best mechanism to deliver answers for the future. If the state were to   "absorb risk," it could employ these industrial giants to good effect. But the state must also be able to curtail the tendency for corporations to maximize their entrenched positions and purvey ever more oil and gasoline, continue a car culture, substitute medication for other therapeutic modalities, exaggerate consumer goods by a science of persuasion, and so on.

The consumption ethic that has been promoted by corporations for the purpose of selling their products now has a life of its own. We have convinced ourselves, or advertising has convinced us, that happiness derives from consuming things and that prosperity and well-being can be measured by the quantity or quality of goods and services. It may seem that this materialism was always the primary human motivation, but it is not so.

Strangely, standard economic theory has no room for advertising, promotion, or sales efforts in its supply-demand equilibrium. These activities, which to the lay observer can see clearly are manipulations of demand, but to a free-market economist they are somehow aspects of supply. Advertising exists not to persuade, but to inform. Beer or perfume purveyors may spend more in advertising than in production, but this is not important.

This manipulation of demand is in part a function of affluence.

     "There is little doubt as to the ability of the industrial system to serve man's needs. As we have seen, it is able to manage them only because it serves them abundantly. It requires a mechanism for making men want what it provides. But this mechanism would not work - wants would not be subject to manipulation - had not these wants been dulled by sufficiency."

But the control of appetite is not control of belief. In the latter endeavor, the corporation and the state come together to create an illusion, an illusion which insists on the excellence of the current regime and so obscures the true nature of the challenges the society must deal with.

     "If we continue to believe that the goals of the industrial system - the expansion of output, the companion increase in consumption, technological advance, the public images that sustain it - are coordinated with life, then all of our lives will be in the service of these goals. What is consistent with these ends we shall have or be allowed; all else will be off limits.
     ...

     "All other goals will be made to seem precious, unimportant or antisocial. We will be bound to the ends of the industrial system."

Does it have to be that way? Galbraith, writing forty years ago, said,

     "The future of the industrial system is not discussed partly because of the power it exercises over belief. It has succeeded, tacitly, in excluding the notion that it is a transitory, which would be to say that it is a somehow imperfect, phenomenon. But General Motors, General Electric and U.S. Steel are viewed as an ultimate achievement. One does not wonder where one is going if one is already there. Yet to suppose that the industrial system is a terminal phenomenon, is per se, implausible. It is itself the product ... of a vast and autonomous transformation.

...

     "It would be strange were such a manifestation of social dynamics to be now at and end. So to suggest is to deny one of the philosophical tenets of the system itself ... that change is the law of economic life.

In fact, the industrial system, the large corporation does not have to disappear for solutions to be put in place. But the state must free itself to act as the representative of long-term survival and rational economic actions.

"... the expansion of public services that are not sponsored by he industrial system, the assertion of the aesthetic dimension of life, widened choice as between income and leisure, the emancipation of education - require that the monopoly of the industrial system on social purpose be broken. This will not ... be welcomed by all.... But it is not inconsistent with the continued existence of that system."

     If other goals are strongly asserted, the industrial system will fall into its place as a detached and autonomous arm of the state, but responsive to the larger purposes of the society.

This potential and the necessity to manifest it was seen by Galbraith forty years ago. The same exists today. The potential and the need to manifest that potential. The actual economy is a Corporate Oligarchy with threatens the very society it purports to serve. The trajectory described by it is far wide of the mark.

Income must be reconnected to value, not power. Corporations must become partners, not masters. The state must regain its place as the representation of the people and their interests, not as a circus for dominant interests to manipulate.

2009-08-19T10:06:00.000-07:00

Chapter 7:

Hyman Minsky and the Rise of Economic Instability

Bio
Context
The Instability of the economy
The plae of investment
Prices

No more powerful explication of economic thought has been propounded than that of Hyman Minsky. Relatively unknown during his lifetime, Minsky is the theoretical main line of Demand Side theory from Keynes to today.

Perhaps the most powerful line of Minsky's thought derives from the work of Michal Kalecki (kah-les-key), a Polish economist from the era of Keynes. (It is reported that at the London School of Economics, Keynes' model was taught as the Keynes-Kalecki model.) Kalecki's assumptions and equations were simple and plausible. Kalecki's elegant application of the mechanical logic of algebra began with them and then opened up prices, productivity, wages, profits, and investment. Alegebra is a mechanical logic and its proofs are logical proofs. Contrast this with the use of calculus in economics. The latter although complex and impressive in its precision, implies assumptions that are never explicit, the integrity of variables and a closed system that is belied by economic reality.

Michal Kelecki's most simple assumption was that workers consume all their income. Of course the assumption is not completely true, but it is more true than not and is not fatal to the analysis when it deviates. Deviation, for example, in Neoclassical economics from the assumption that all firms are price takers is fatal to that analysis. In Rational Expectations, it is fatal, in that the analysis falls apart when we see that the assumption that market participants, indeed all economic actors, are imbued with economic omniscience deviates from reality.

Kalecki showed that when his assumption was allowed and in an economy with small government and little trade, investment equals profits, or profits equal investment. Minsky then demonstrated first that price is positively related to the wage rate and to the ratio of investment goods to consumption goods production, and negatively related to labor productivity. (See pp. 140ff in Stabilizing an Unstable Economy.

But let's consider what Minsky's relationships mean. It's a no-brainer that prices vary in the opposite direction as productivity, because, productivity simply means producing more with the same labor.
But the second part of this finding is very instructive. The algebra shows what we might also derive from common sense. As investment goods are emphasized over consumer goods, the price of consumer goods tends to rise, because, basically, workers in both sectors are bidding for the output of the consumer goods sector. So when the ratio favors investment goods more, demand for consumer goods is higher and output is lower.

But the implications are not all so common-sensical. The Kalecki demonstration that profits equal investment combines with this revelation that as new investment goes up, so do prices, to produce a condition in which higher prices, higher investment and higher profits coexist. Since investment also connects positively with output and income, we can expect these two -- output and income -- to be in the same virtuous soup.

This indeed was a somewhat surprising empirical finding of our research on economic performance by president, which you will see in Chapter xx. We found that in the postwar period employment is higher, unemployment lower, investment higher, corporate profits higher and GDP growth better when a Democrat is in the White House. It surprised us somewhat that with all the effort by Republicans to push companies into profitability, some would say at the expense of others, that is, the whole supply side idea, that they were not able to accomplish profits better than Democrats. The Kalecki-Minsky analysis demonstrates why it has to be.

Prices, Minsky says, carry profits, the raison d'etre for investment. Most basic treatments of microeconomics begin and end with fixed costs, variable costs, average costs and marginal costs. Prices are determined by marginal costs and where the marginal cost curve intersected the demand curve. This may be true, Minsky says, for price takers. But a whole great swath of the economy, including the dominant capital-intensive sectors, is composed of firms which more or less set prices and vary output according to demand.

These firms operate on the basis of a set of nesting average cost curves, the highest of which includes capital asset validation cost, or profits in the normal use of the word. Such firms keep prices at the requisite level when demand falls by their market power, pricing power. Without this ability to constrain price movements, they may not be able to employ expensive and highly specialized capital assets and large-scale debt financing, Minsky observes. So a control of the market that is not allowed in primitive economics is actually necessary in the practice of capitalism.

MINSKY'S CHARTS OF NESTING CURVES
We include that mention here not because we expect you to get it, the nesting average cost curves and so on, but just to let you know it is there in Minsky, as it is in the real world, and it informs what follows.

Returning to the propositions derived from the insights of Kelecki. Minsky expanded these by introducing big government and trade and workers who save. Elegant and simple algebra yields some remarkable insights.

Note here and we'll explain more in a minute that Minsky's profit is not the same profit with which we are familiar, nor that which we measured in our comparisons of economic performance by president.

Nevertheless, when government and taxes and deficits are introduced, something remarkable appears. It can be shown that after-tax profits equal investment plus the government deficit. When there is no investment, profits equal the deficit. See the details on page 148.

What are the implications of this? One implication is certainly that the big business types who encouraged the tax cuts to promote business should not now be bellyaching about the deficits. They are supporting profits. Now let's look at exactly what profits they are supporting.

Minsky's profits he also terms the "surplus," and it is not only the return on capital we normally think of as profit, but all the returns which are not technologically determined costs of production. These include advertising and professional services, executive salaries and overhead costs, costs of financing and the aforementioned costs to validate capital assets.

Two things jump out at me. One is that the profit or surplus feeds the white collars and presumably the big salaries as opposed to the blue collars on the production side. The other is that price-taking firms are disciplined into being more lean and less top heavy. It appeals to me as justification for taxing incomes progressively.

But let's go back to the price takers versus the price makers. What happens when demand falls? In the case of price takers, demand is reflected by a price that runs back along the marginal cost curve. In the case of price makers, who set the price and prevent its falling by market power, something else happens.

If output drops below the first critical average cost curve, capital asset prices are no longer validated and investment in new capital assets stops -- with implications across the economy for incomes and output. If output drops below the second critical curve, fixed debt payments can no longer be supported, and the various financing instruments come under pressure. Of course, the overhead and executive costs are compressed to some extent, but these may be resistant. For example, firms may increase advertising in attempts to gin up demand.

And when overall demand affects many firms, the same kinds of financial instruments come under pressure and we walk into the kind of crisis we have today.

See that the deflation is resisted by such firms on their products, because they have individual pricing power, but that the drop in output affects incomes and investments and financial arrangements dramatically -- without affecting price.

So my take here is that we ought not to be too ecstatic that deflation is not spiraling. The cost-cutting and absence of investment and the pressure on the financial sector, all too evident in the current stagnation and apparent in declining payrolls may likely mean more bad jujus.

AND of course, business cash flow is being supported mightily by government deficits.

I hope this is semi-clear. It is new to us in this form, and it is a lot to digest. But here at the micro level, you can see what about modern capital-intensive corporate capitalism Minsky found so unstable.

2009-08-12T09:40:00.000-07:00

Chapter 8:

James K. Galbraith and the Predator State

Bio
Context
Answer to current mess via Moyers
Predator State
Rational State

From Bill Moyers October 24, 2008

ES GALBRAITH: Pleasure to be here.

BILL MOYERS: How perilous is this situation?

JAMES GALBRAITH: Oh, very much so. This is the big one. I have been working on financial crises since the New York City rescue in 1975. And this is, by far and away, the biggest threat to the system as a whole that we've seen in my lifetime and I think the biggest threat since the late 1920s.

BILL MOYERS: Is it possible that the adrenaline of fear could push us over the brink into panic so that we stop acting rationally or deliberately?

JAMES GALBRAITH: Fear is a factor. But we have an enormous advantage over our predecessors in 1929. We have the fact that the New Deal happened. And we have the institutions of the New Deal, though they have been badly damaged in the last decade, they are still with us. We have deposit insurance. We have Social Security. We have a government which is capable of acting as the lender of last resort, which can borrow and spend as needed to deal with this crisis.

So here in the United States the capacity to handle the crisis exists. What we need is a government that's willing to use that capacity, that believes in it. And that's where the collapse of the old objectivism of Alan Greenspan is such a fundamental feature of the present situation, and very timely. With the collapse of that system of ideas perhaps the way will be cleared for thinking afresh and clearly about the problems that we face and how to solve them.

BILL MOYERS: Well, they have been acting as born-again believers in government intervention.

JAMES GALBRAITH: I think, though, that there's still a great deal still to be learned and still be to done. We are going to hear a great deal in the next few weeks about the need for a stimulus package. And a lot of people will be talking about how they will be conceding that the government should get involved short term.

But what needs to be stressed is that we've seen a breakdown of an entire system. The consequence of the failure of regulation, of supervision of the banking system over the past eight years, has been to cause a collapse of trust, a poisoning of the well.

BILL MOYERS: Trust?

JAMES GALBRAITH: Of trust, yes. Banks -

BILL MOYERS: Between?

JAMES GALBRAITH: Banks no longer trust each other because they no longer know whether their counterparties are solvent. Customers no longer trust the banking system. Banks no longer trust the people who would like to borrow from them for commercial purposes. This is a poisoned well. It is going to take a fair amount of time for it to be cleaned up.

BILL MOYERS: Fair amount of time? What do you mean?

JAMES GALBRAITH: My feeling is, if it is done correctly, aggressively, effectively, we could begin to work out of it in three years. But it is not a problem that's going to be solved with a six-month program.

BILL MOYERS: What scares you most right now?

JAMES GALBRAITH: Well, a week ago or two weeks ago I would have said the possibility that Phil Gramm might become Secretary of the Treasury.

BILL MOYERS: Your former Texas soul mate, right?

JAMES GALBRAITH: Yes, exactly. Yeah. We have a contest between a philosophy of deregulation, of de-supervision, a philosophy of anything goes. Gramm himself was the architect, a deep architect of the speculative markets that have just collapsed. And an alternative which says that there really has to be a pragmatic approach to these problems. And that's a choice the American public obviously is going to be making in a few days.

BILL MOYERS: What's the worst-case scenario you think about late at night?

JAMES GALBRAITH: Right now the thing that troubles me most is not the United States. The thing that troubles me most is that the same ideas of deregulation, of free markets, were applied in the construction of modern Europe. And the Europeans don't have the institutions of the New Deal, a central bank that can lend as necessary.

BILL MOYERS: Right.

JAMES GALBRAITH: Government that can borrow as necessary; that can take the initiative. They have expanded themselves into Eastern Europe in a way in which Communism was replaced by nothing. And a financial collapse is going on there now is, in many ways, more profound than the one we are experiencing here.

BILL MOYERS: But we've seen Gordon Brown, the Prime Minister of Britain, step forward in a way that our own government hasn't and try to orchestrate a European-wide response to this.

JAMES GALBRAITH: That is true. And that is, you know, collection of the finance ministers getting together over the weekend to try and do this on an ad hoc basis. Mercifully, we have the institutions of government in this country that can act. The Europeans are winging it. They have to go against their charter of the Central Bank, against the Maastricht Treaty and its restrictions on government spending, government deficits. They- that problem is a systemic problem. Our problem is a policy problem. We can solve our problem.

BILL MOYERS: Isn't our government winging it, too? I mean, the NEW YORK TIMES this week-

JAMES GALBRAITH: Yeah.

BILL MOYERS: Had a long story saying that Secretary of Treasury Paulson was behind the curve at almost every turn.

JAMES GALBRAITH: That's no doubt true. First of all, the crisis had been developing for a year. When it broke, he sent up a three-page bill to Congress. Many people said that's a power grab. My view was it was a punt. It said to the Congress, "You take this ball. You write the legislation," which Barney Frank and the other leadership of the Congress actually did do. And they came back. And eventually they passed a bill. And Paulson has been improvising ever since. He's done a number of things that actually I was recommending as early as the 25th of September in the "Washington Post". Guarantee all deposits in the banking system. Support the commercial paper market. Take out equity investment in the banks, effectively partially nationalizing them. All of these things which were unimaginable in mid-September are now policy, even though they weren't, strictly speaking, part of the bill.

So we are improvising very fast. The next problem is going to be that the economy needs to be dealt with, not just the financial sector. The fact is we have a million homes in foreclosure. That number's going to be rising. It could be two and a half or five million in a few months. We are going to have to take very significant steps to try and keep people in their homes, to try and minimize the amount of abandonment, the amount of blight, the amount of sort of permanent damage to the houses out there and to the people who live in them.

BILL MOYERS: Yeah, that's one calamity I wanted to ask you about. You own a home on which the value of it is far less now than the mortgage that you have to pay off. What do we do about that?

JAMES GALBRAITH: You renegotiate the mortgage. And that is something that has to be done on a case-to-case-by-case basis with government help. That is what, in the 1930s, Roosevelt established a Home Owners' Loan Corporation to do. And we're going to need to go back to that model and do something similar. Sheila Bair, the head of the FDIC-

BILL MOYERS: Federal Deposit Insurance Corporation.

JAMES GALBRAITH: - has proposed something quite similar.

BILL MOYERS: And so has Governor John-

JAMES GALBRAITH: So we're-

BILL MOYERS: -Corzine of New Jersey is coming forward with something like that. Details to follow. But I know he's groping with that. Other governors are, too.

JAMES GALBRAITH: Yeah.

BILL MOYERS: Can they do it on their own at the state level?

JAMES GALBRAITH: No. It is going to require federal organization and federal funds. And the states have another problem, which is states and localities fund themselves from the property tax and the local economies.

BILL MOYERS: Right.

JAMES GALBRAITH: Those are collapsing. So they need support and help to maintain their public services, to keep their staff, their civil servants on payroll so that you don't complicate the housing problem, among other things.

BILL MOYERS: And since there's no private capital from that they can borrow now, where do they go?

JAMES GALBRAITH: Well, they have to - the federal government is going to have to provide both operating revenue and support for capital investment by state and local government.

BILL MOYERS: What about the other calamity? The other calamity is that people nearing retirement and the elderly, have really been hit hard in their pension plans. What happens to them?

JAMES GALBRAITH: Well, you can't make people whole individually because everybody made different portfolio choices. Some were more in the stock market, some less. Those who were more in the stock market have been hurt harder. What you can do is protect the population as a whole. And we have a system for doing that. It's called Social Security.

It supports today about 40% of the American elderly population has basically no other income. It's more than half of the retirement of maybe 50 or 60% of that population. Social Security benefits, except for inflation adjustment, haven't been raised in a generation. We ought to think about replacing the losses to some degree in the aggregate that have occurred in the markets by raising Social Security benefits and particularly raising them for the poorest and most vulnerable.

BILL MOYERS: For a temporary measure?

JAMES GALBRAITH: Well, I'm in favor of doing it on a permanent basis.

BILL MOYERS: But, you know, you and everybody else have been reading or talking to or calling for more spending, more spending because that's the only way you say to get capital into the system. But where's that money going to come from, Jamie?

JAMES GALBRAITH: The government has no problem with money. What we're learning, first of all, is that the dollar remains the anchor currency of the world. The euro is the one, is the currency that's collapsing right now, not the dollar.

Uncle Sam's credit is excellent. Uncle Sam can borrow short term for practically nothing these days. Everybody wants to have Treasury Bills and bonds because they're safe. Uncle Sam can borrow for 20 years at 4.3%. That's the same rate that the United States could borrow at for 20 years in the last month of the Eisenhower administration. So from our point of view, we're actually well placed, I mean, as the government of the United States is well placed to take the lead in pulling the country and the world out of this crisis.

BILL MOYERS: But even Barack Obama's website calls the deficit America's "Domestic Enemy." Even he's aware of the fact that the deficit's beyond sight.

JAMES GALBRAITH: Well, the deficit isn't beyond sight. The deficits in the Bush administration in relation to the size of the economy were never all that large. They were certainly larger than they were under Clinton, but that was in part necessary because of the changed economic situation, the collapse of the dot-com bubble in 2000.

The United States government's credit is good. The deficit is a financial number that people are going to have to get used to because there is no way in these circumstances of avoiding an increase in the deficit. One of two things can happen. The government can take action and help stabilize the economy in which case we will have more spending but also more employment.

Or the government cannot take action and let the economy collapse in which case we will have much less tax revenue. The deficit is going to be larger either way. There is no way of avoiding that. The only question is do you work to have a good economy or do you accept a terrible economy?

BILL MOYERS: What are the negative effects of a soaring deficit?

JAMES GALBRAITH: Well, the one thing I would have worried about is that we might not find lenders who are willing to provide funds to the U.S. government, that the Chinese or the Japanese might decide that they would rather be in some other currency and that we'd then have trouble with inflation. But that's not going to happen.

It's not going to happen because, as it turns out, the major alternative, the euro, simply isn't viable as a reserve asset for the rest of the world. It's the dollar or nothing. So the United States basically can finance itself to the extent necessary to deal with this crisis. And I'm right now quite sanguine about that, quite confident that we won't face a problem.

BILL MOYERS: You call your book THE PREDATOR STATE, what do you mean predator?

JAMES GALBRAITH: What I mean is the people who took over the government were not interested in reducing the government and having a small government, the conservative principle. They were interested in using these great institutions for private benefit, to place them in the control of their friends and to put them to the use of their clients. They wanted to privatize Social Security. They created a Medicare drug benefit in such a way as to create the maximum profit for pharmaceutical companies.

They used trade agreements to extend patent protections for various interests or to promote the expansion of the corporate agriculture's markets in the third world. A whole range of things that were basically political and clientelistic. That's the predator state.

BILL MOYERS: You call it a corporate republic.

JAMES GALBRAITH: It is a corporate republic.

BILL MOYERS: Which means that the purpose of government is to divert funds from the public sector to the private sector?

JAMES GALBRAITH: I think it's very clear. They also turned over the regulatory apparatus to the regulated industries. They turned over the henhouse to the foxes in every single case. And that is the source of the decline in, the abandonment of environmental responsibility, the source of the collapse of consumer protection, and the source of the collapse of the financial system, all trace back to a common root, which is the failure to maintain a public sector that works in the public interest, that provides discipline and standards, a framework within which the private sector can operate and compete. That's been abandoned.

BILL MOYERS: We saw what Alan Greenspan said yesterday. But did you see what the chairman of the Securities and Exchange Commission, Christopher Cox, said? I mean, it was one of the great recantings in modern American history. Quote, "The last six months have made it abundantly clear that voluntary regulation does not work."

Now, we all know that the government can screw up, too. We all know that government can make serious mistakes. What kind of regulation do you think we should have that doesn't poison and punish entrepreneurial talent but protects the public interest?

JAMES GALBRAITH: Well, first of all, anyone who thought, up until six months ago, that voluntary regulation could work was either being dishonest or delusional. Voluntary regulation is regulation that, by its nature, you can evade. And what happens is that the people, who are most intent on evading it, on not respecting the standards, come to take over the process. Their profits are better. And so they drive the complying firms and businesses to the wall. They out-compete them.

You need to have a mandatory system so that the firms which are more technologically progressive, which are safer, which are more complaint, which provide, which are prudent in the financial sector, which maintain credit standards so that those firms have a competitive chance. That's the first purpose of regulation.

It is a framework which it favors, when it's done properly, it's a framework which favors the more efficient, the more progressive, the elements that are prepared to work within the guidelines set by a larger public purpose.

BILL MOYERS: What kind of regulation do you think might be most effective?

JAMES GALBRAITH: The, well first of all, we need to clean up the mess that's there. And that's going to include a fair amount of legal intervention, criminal prosecution, malfeasance. There was a lot of fraud in the housing sector, in the, amongst the loan originators, amongst the appraisers. This all needs to be investigated. And people need to be moved out of positions in the financial industry that they have abused.

The regulatory system going forward is going to have to be basically like a utility. It's going to have to treat banking like a utility with limitations on growth, on rate of return, and on credit in such a way as to be much more transparent, to make it much easier to evaluate financial products that are traded. None of this over-the-counter, occult, too complex to value stuff.

We need to end the offshore tax havens and other ways in which institutions have hid out from their responsibility to the country to pay their share of taxes. And we need to have a set of prudential standards that are reasonable and that basically can put the business of finance on a sustainable footing. It'll be a much less glamorous business going forward. But it will be more reliable for the country as a whole.

BILL MOYERS: You are such an experienced economist in your own right. But I hesitate to bring the spirit of your father to this table. He would have been 100 last week had he not died two years ago, right? And his classic book, of course, one of his classic books is "The Great Crash of 1929". Is the situation today comparable to what happened when your father was a young economist?

JAMES GALBRAITH: It is. The situation today is very similar to the moment of panic and collapse that we saw in 1929. And for very similar reasons. An abandonment of the supervisory responsibility that should have been applied to keep the speculation and the fraud and the abuse from getting out of control. So there's going to be a major period of correction. And dad, in writing this in 1955, talks about how memory fades and how eventually, although so long as people remembered '29 it wouldn't be repeated, eventually it would be forgotten and the underlying speculative impulse would come back. So the book, in addition to being a great read, is really prescient in a very balanced way. But I will say that we're not going to go back to 1929 because in 1929 we hadn't had Roosevelt. We hadn't had Kennedy and Johnson. We had had them now. So we have a body of history to work with.

BILL MOYERS: There's a precedent, you're saying, that there are tools there if people want to use them.

JAMES GALBRAITH: Tools, not only precedent, there are institutions. There's a government structure. And if we use them, we can avoid, we can't avoid '29. But we can avoid 1930 and 1931, 1932, when-

BILL MOYERS: When-

JAMES GALBRAITH: -output fell by a third, unemployment rose to 25 percent of the labor force and a third or more of the banks in the country closed and people lost their savings. In fact, we are already in a position of moving to take steps to prevent that from happening. We need to recognize, though, that we can never go back to a system of this kind of buccaneering finance driven, Wall Street-led economy in which a group of people who are profoundly unqualified to run the country are, in fact, dictating policy from perches here in Manhattan.

BILL MOYERS: But there are capitalists like Steve Forbes, I just read a long article by him in the current issue of "Forbes Magazine," who argue that people like you are going to go too far and that it was actually the government's excesses and failures in the '80s and '90s that contributed to what began to happen in 2007 with the meltdown. And that if you have your way, people like you have your way, you will criminalize business. You will raise taxes and dry up the economy. You will take government unchecked into the same kind of catastrophe that unchecked Wall Street has carried us. How do you answer a Steve Forbes?

JAMES GALBRAITH: Well, first of all, I very much agree with him, that it was failures of government that were responsible for this. It was the actual failure, the abandonment, the neglect of the supervisory regulatory responsibility. That's at the root of this.

Just as you cannot prosper without a private economy, you cannot prosper without an effective autonomous government capable of thinking for itself, capable of balancing things out, of standing for other interests, of standing for labor and consumers and for the public interest as a whole. If you don't have that, you're going to get these pyramids, these bubbles, these epidemics of fraud and abuse, and ultimately the collapse of trust and the collapse of the economy itself. That's what's happened in the predator state.

BILL MOYERS: I wrote down something you wrote elsewhere, that struck me. You wrote that after World War II our American system wasn't imperial. Quote, "We spoke instead of community, of freedom, of common purposes and common values. And the world took us seriously because we had paid our dues." What's happened to those values?

JAMES GALBRAITH: Well, it's clear that world has lost its confidence in the responsible role of the United States. Iraq is viewed by the world as reckless and self-serving rather than being a necessary step to protect the mutual security.

In the financial sector, the world viewed us as a safe haven because they believed we had effective systems for legality, transparency and security. That's taken a hard knock. But we are rescued for the moment by the fact that other people's systems turn out to be even worse. I believe that you can turn a page and that you can rebuild the position of the country in the world community if you do so in a way which is fully credible. New people, new philosophies, new policies.

BILL MOYERS: The book is THE PREDATOR STATE: HOW CONSERVATIVES ABANDONED THE FREE MARKET AND WHY LIBERALS SHOULD TOO. James K. Galbraith, thanks for being with me.

JAMES GALBRAITH: Thank you.

2009-08-08T09:46:00.000-07:00

Chapter 9:

Joseph Stiglitz and Globalization

     Economics has been driving globalization, especially though the lowering of communication and transportation costs. But politics has shaped it. The rules of the game have been largely set by the advanced industrial countries - and particularly by special interests within those countries - and, not surprisingly, they have shaped globalization to further their own interests. They have not sought to create a fair set of rules, let alone a set of rules that would promote the well-being of those in the poorest countries of the world."

- Joseph E. Stiglitz

Bio
Context
Information and markets (segue from Minsky)
Globalization and NeoLiberalism
Global Warming

"Globalization" is a term for the coming together of the world economically, the integration of the world's economies. It has been described in some places as inevitable but benign, elsewhere as lethal. Trade between peoples and nations has been around for as long as people could travel, nearly as long as humankind. As the means of transportation became less expensive and more reliable, trade grew. Now trade has grown again. New industrial nations have risen in Asia founded on export. Trade now includes services as well as goods. But increased trade is not all that is meant by Globalization. Also implied is the free flow of capital and the opening and integration of markets. And while "trade" denotes an exchange, the current phenomenon - at least for the U.S. - is one of borrowing and lending.

The model that describes the gains from trade was developed in the Nineteenth Century by British economist David Ricardo (1772-1823). It is based on the concept of comparative advantage. Where one country might have a comparative advantage in wine and another in wool, it benefits both parties to trade. "Comparative" signifies other than absolute. For example, if country A can make 8 gallons of wine or raise one sheep and country B can make only 4 gallons of wine per sheep, it doesn't really matter if "A" can make 100 gallons per man and "B" only 20. The benefit exists to trade sheep (or wool) for wine. No matter the relative level of prosperity, if we can get more wine by growing sheep and trading wool for it than by growing grapes and producing it ourselves, we are better off to do so.

Ricardo's principle of comparative advantage and win-win from trade has the precision of the hypothetical. Ricardo's analysis occurred in the historical context of trade between relative equals, but also in the context of the British Empire. In the hypothetical world of comparative advantage, British Colonialism and Imperialism were conveniently ignored. The real faces of trade and Globalization both then and now are more apparent if we remember Galbraith's insight, that income is a function of power, not value. Just as in Ricardo's time, today we witness the domination of one people by another for economic benefit. Were Ricardo's model accurately reflected today, the well-being of all peoples would improve, general prosperity would improve. Although the issue is clouded by an enormous increase in the world's population, it is apparent that poverty has expanded and the disparity between rich and poor - nations and individuals - has expanded.

While the principles of trade remain solid, the practice of Globalization often involves gains based not on comparative advantage, but on control of the exchange. It is not the vintner nor the shepherd who is better off, but the one who arranges the transport of their goods. The returns from trade possible for the well-being of the broad society have been captured by the businesses which sponsor the trade, who also dominate the suppliers and control the distribution.

For example, within the United States, Globalization has meant cheap imported manufactures and the loss of manufacturing jobs. Trade agreements have been a target for the displeasure of labor unions and others because the costs have manifested in lower wages and loss of the manufacturing base, with the related loss of jobs. The benefits have manifested in higher corporate profits and in lower consumer prices. The net positive impact of freer trade undoubtedly available in theory is in practice frustrated because the gains have not been widely shared. The consuming public sees the outsourcing of jobs and objects silently, or at best sporadically, even as it fills the parking lots at Wal-Mart to buy the cheap Chinese goods.

The word "trade" denotes an exchange of goods or commodities. In this concept, the currency of a country is simply a medium of exchange, eliminating the need for direct barter. If there is a difference between the values of the traded goods, imports and exports, it means a debt has been incurred. The "exchange" element of trade is often missing with respect to the U.S. today. Accompanying Globalization and financing many American purchases, has been an explosion of debt. China and Japan and others have literally lent the U.S. consumer the wherewithal to buy imports. The trade deficit itself is nothing other than a measure of this capital inflow in the form of lending. And this trade deficit has been huge and growing since the late 1970s.

Long-term and chronic trade deficits such as the United States has experienced over the quarter century amounts to a failure of free trade theory. In that theory, the currency will adjust when trade consistently benefits one side, so that its goods become relatively more expensive and demand balances. "Trade" means trade of goods for goods through the medium of currency. The U.S. deficit instead an exchange of foreign goods for U.S. dollars.

We will deal with questions about the dollar in Part II. Here we will look at a vision of Globalization from the perspective of one of its most astute critics, then glance at the post-war experience, and finally take on two of the important issues, like immigration and debt cancellation, that are part and parcel of trade.

Washington Consensus

"Globalization," as mentioned, has more meanings than simply increased trade and open markets. Globalization has also come to mean free capital flows, corporations free from the fetters of governmental interference, and privatization of governmental activities. These latter meanings are more rightly called the "Washington Consensus," a name derived from the proximity of the headquarters of the International Monetary Fund (IMF), the World Bank and the U.S. Treasury in Washington, D.C. These institutions have been the economic and financial enforcers of free market capitalism. (In Part II we analyze the intellectual construction of the Supply Side camps more completely in a chapter entitled Neoliberalism.)

The Washington Consensus is an extreme version of Classical economics which supposes a market answer to virtually every situation. Joseph E. Stiglitz defined the Washington Consensus in these terms:

     "These policies focus on minimizing the role of government, emphasizing privatization (selling off government enterprises to the private sector), trade and capital market liberalization (eliminating trade barriers and impediments to the free flow of capital), and deregulation (eliminating regulations on the conduct of business). Government had a role in maintaining macro-stability, but the attention was on price stability rather than on output stability, employment, or growth. There was a large set of dos and don'ts: do privatize everything, from factories to social security; don't have the government involved in promoting particular industries; do strengthen property rights; don't be corrupt. Minimizing government meant lowering taxes - but keeping budgets in balance."

Where the policy program of the Washington Consensus has been applied, the results have been grim. And by reason of the coercion of the IMF and World Bank, it has become the practiced economic regime in too many developing countries.
A recipient of the 2001 Nobel Prize in economics for his work demonstrating the fallacy of market efficiency, Stiglitz was chief economist to Bill Clinton and later chief economist at the World Bank. His position inside the institutions which foster and promote the Washington Consensus make Stiglitz' two books - Globalization and Its Discontents and Making Globalization Work authoritative and their judgement all the more telling.

The Washington Consensus has been a recipe for crisis and decline. In East Asia, those countries like India, China, Malaysia and Vietnam which resisted free capital flows have prospered. Those who have been persuaded by the IMF and World Bank to allow capital in and out unhindered have been burned. "Hot money," capital moving in and out of markets looking for microscopic advantages, accounts for literally trillions of dollars per week, far more than the combined reserves of all governments. Hot money leads directly to instability. (This and one remedy, the Tobin Tax, is discussed in more detail in Part II.) In 1997 a run on the Thai currency, the bhat, led to what at the time was called the Asian Currency Meltdown. Central banks of the affected nations exhausted their reserves in a futile effort to prop up their currencies. Foreign lenders panicked. Loans were called in. Massive bankruptcies ensued. The banking system went into crisis. The IMF rode to the rescue - of the foreign lenders. Large loans and a laundry list of conditions wee offered the affected nations. The loans effectively shifted the debt from the individual companies to their governments. The stipulated conditions for these loans are familiar from the Washington Consensus - government spending cuts, tax increases and higher interest rates.

Even more excruciating has been the experience of Russia since the fall of Communism. During the 1990s, In the first years of the new market economies of the former Soviet Union, the IMF and Treasury prescribed free market "shock therapy" - immediate privatization, opening of capital markets and elimination of price controls. The result was instant economic trauma - hyperinflation, rampant official looting by so-called oligarchs of the formerly state-owned industries, capital flight, impoverishment of millions. The new day of prosperity predicted by the Washington Consensus appeared in Russia, as elsewhere, in the form of Depression. Output fell by one-third from the already spare level of the Communist era. Pensioners whose stipends were fixed were wiped out by the inflation and left to sell apples in the streets or to starve. (Life expectancy itself in Russia fell by four years between 1990 and 2000.) This experience was imitated by other members of the former Soviet Union and eluded only by the few who eluded the therapy, Slovenia and Poland, for example.

In Africa after freedom from Colonialism in the 1960s many nations experienced a sequence of economic mistakes and misrule which brought as part and parcel large debt, often from arms purchases, often from large inappropriate industrial projects, often from simple graft. As a condition for financial assistance to deal with this debt, the IMF and World Bank's template demanded structural adjustment policies (with the apt acronym SAP). SAPs were the familiar strict budgetary and borrowing constraints and privation policies prescribed elsewhere by the Washington Consensus. In Africa they were completely inappropriate to nascent economies whose ill-educated work forces and primitive infrastructure made them poor competitors for the oft-cited but rarely seen private investment capital. Population pressures, AIDS, declining agricultural productivity and in some cases continued misrule have left desperate human conditions across the continent.

Latin America, which as Stiglitz says, "embraced the Washington Consensus policies more wholeheartedly than any other region" has suffered in measure.   Previous to 1980, the region nurtured development by protecting its domestic industry with high tariffs. This strategy of import substitution was pioneered by the Western industrial democracies and has been used extensively in the Asian success stories (although with more subtlety and government assistance).

The high interest policies of the United States in 1980 infected loans in Latin America. Debt service ballooned and triggered the default of several of the largest economies - Mexico, Brazil, Argentina - and others. In an attempt to staunch inflation and find a way out of the depression resulting from the debt crisis, Latin America embraced the minimalist government and strict austerity of the Washington Consensus. Early success soon wilted. Self-congratulation at the World Bank and IMF and commendations from their free market apologists faded some time later. The 1980s in Latin America was lost to the debt crisis and its mismanagement. The 1990s offered only pallid growth. The North American Free Trade Agreement (NAFTA), a further "open market" trade agreement effected in 1994, has proven no more fertile, and has led instead to the current immigration crisis, discussed later in this chapter.

The Successes

The Asian success stories are China, India, South Korea, Japan, Malaysia, Singapore. These are the countries which have avoided the minimalist, market-knows-best, free capital movement approach. The governments of these nations have directed development, protected infant industries with tariffs, and ensured widespread sharing of prosperity and liberal access to education. In an earlier time, Japan was also a success story. The original postwar successes were Europe, and of course, the United States of America. All of these employed similar policies, but policies very unlike those imposed by the Washington Consensus. We now take a closer look.

The Marshall Plan - A Success

Just as when the New Dealers applied Keynesian programs out of political imperative, the most successful development and trade plan in history rose out of political imperative. The New Deal addressed the human needs of Depression, but was also an answer to the domestic rise of Fascism and Communism, two competitor economic schemes which seemed to be working when market capitalism was not. As Galbraith said, "The Keynesian Revolution occurred at the moment in history when other change had made it indispensable."

Postwar trade began with American economic dominance. The industrial plant of Europe and Japan had been destroyed, and that of Russia was struggling under a nascent arms race. European production facilities and farms had been decimated. Communism was alive and present in every country. (The Social Democratic parties in Europe today are, in fact, direct descendants of a non-revolutionary Marxism.) Entire populations were hungry and jobless. The American answer was the Marshall Plan, named for its organizer, twice Time's Man of the Year, the "Great Man" as Truman called him, General George C. Marshall.

The Marshall Plan rebuilt Europe through loans and grants. But although the economy and infrastructure of Europe lay in shambles, an educated and skilled work force remained. Local planners and the indigenous leaders of hundreds of European communities organized the rebuilding and European labor executed it. This meant employment for the unemployed and a society reorganized around peaceful economic enterprises. It also meant immense good will toward Americans and dynamic new markets for American goods.

While the view of the American public was decidedly more open in the early 1950s than in the protectionist 1930s, fear of a return to Depression was still alive. In order to implement the Marshall Plan, the Truman Administration had to overcome resistance from many, led by Republicans, who believed the operation to be more than the nation could afford. The recently validated and popularly respected Keynesian Demand Side economics was decisive.
Because of the resurrection of Europe as a trading partner and market for American goods, the Marshall Plan was a great source of prosperity in subsequent decades, too, perhaps surpassed only by the GI bill in terms of practical economic benefit.

Today the prosperity of Western Europe and Scandinavia is high. The standard of living for most approaches or exceeds that of the U.S. Did Europe employ the free market fundamentalism advocated by the Washington Consensus? Quite the contrary. Government has been intimately involved with every part of these economies, not leaving the private sector to develop in directions prescribed only by free market winds. Taxes have been significantly higher than even in the United States, primarily for purposes of funding social and health benefits. Public construction of infrastructure and operation of industry is common. Only the United Kingdom beginning with the Thatcher era has employed a minimalist government scheme.

Because of its postwar dominance, the trade balance of the United States was invariably in surplus between the end of the war and the mid-1970s, as American manufactures, equipment and agricultural products remade the world. The industrial plant of Europe and Japan was rebuilt, but the products of their new industry were generally inferior. Fiat, meant "Fix it again, Tony." Japanese-made meant cheap and undependable. Even with the oil supply shocks and price spikes during the 1970s, the U.S. maintained its trade surplus.

Then began the presidency of Ronald Reagan.   The loose fiscal policies of the new regime in the White House were countered by tight money policies from the Fed attempting to counter. The dollar was made dear by restricting its supply (the Monetarist remedy for inflation - see Chapter 4).

One effect of corporate control of the economy that Galbraith noted was the multiplying of the private purchasable goods at the expense of public goods. This consumer economy meant more cars, refrigerators and men's deodorant, balanced by less infrastructure, lower education, and fewer social services. The focus on private goods, retail items, tradable goods, was just the mark for Japanese and later Korean and Chinese factories. The 1980s marked the onset, as so often repeated here, of enormous trade deficits, the decline of American manufacturing, the explosion of public and private debt, and the experience of Globalization.

Globalization on the Ground

The cost of Globalization has been lost jobs. The benefit has been lower prices. So long as trade is conducted on terms so favorable to America and includes the indulgence of foreign lenders, there will be little more than pockets of agitation against the costs. In the developing world, however, the costs of Globalization have been far worse. Two particular issues are raised here, by way of example: the need for debt cancellation and the immigration problem. These are treated more completely in later chapters on development challenges and options.

Debt Cancellation. As we have seen, many nations of the underdeveloped world are staggering under huge debt to the international banks. The existence of this debt is a moral and economic travesty. Its cancellation is essential for development to go forward.
Much of this debt is patently illegitimate. Much of the rest is odious.   "Illegitimate debt" includes that generated by failed projects, many of which were not intended to succeed, and that whose primary purpose was to use the country's treasury to channel money to external consultants and multinationals. "Odious debt" is that which was contracted primarily to obtain means to oppress the population or to enrich governmental officials. Creditors are very often conspirators in these activities, but have not been asked to share the responsibility for the consequent debt.

Another section of the debt burden arises from the capitalization of interest. A 1996 report by the British humanitarian organization Oxfam accused the World Bank and IMF of creating a "bizarre financial circus in which more and more aid was being recycled in the form of debt repayment while the debt stock was increasing." Thus the debt has grown over time without any additional borrowing or lending of principle. The extent of this mushrooming problem is not known because of opaque reporting by the World Bank, IMF and other international lending banks.

Debt cancellation has been implemented, but only in flawed forms, with the stipulations of the SAPs for privatizing, budget constricting and exposing domestic markets. As we will see in Part II, these are as crippling as the debt itself. The solutions they offer only perpetuate exploitation. Some nations spend three times or more on debt service than they spend on education. Debt and development need to be incurred on behalf of the people and for public purposes, not for the benefit of lenders, private industries, or corrupt officials. And the Marshall Plan model indicates development is best directed by indigenous business and labor leaders.

NAFTA and Immigration. The "immigration problem" is popularly seen as a border security or a social fairness issue. But it is not for cherished dreams of becoming fast food counter clerks or lawn maintenance laborers that people are drawn to making the dangerous crossing into the United States. It is, rather, economic privation that drives them out of their native countries. Those who stay behind are often supported by the money sent back home from those who leave.

In the U.S. Labor knows NAFTA as the vehicle that move manufacturing jobs offshore. In Mexico, they know NAFTA as the end of the farm economy. The United States demanded under NAFTA an end to subsidies for corn and beans in Mexico. At the same time price subsidies to the industrial farms of the U.S. were expanded. The result was a massive dumping of cheap corn into Mexico, reducing prices by 70 percent since 1994. Farm incomes plummeted and farm families were left with a choice of crossing the border or starving. Whole villages have become ghost towns.

In the US about 2 percent of us make a living on the farm. In Mexico it is over 40 percent. (U.S. price supports do not go to the family farmer, let us be clear. Eighty-five percent goes to the largest operators. It is no exaggeration to say that in order to support millionaires we have been led to militarize our borders and have forced the Mexican agrarian economy dissolve. )

The trade regime that allows the imbalance in favor of the U.S. and developed economies was negotiated in the 1990s on the promise that the next round of trade talks would redress these problems and benefit the agricultural economies of the developing world. The developed world led by the United States reneged on the promise, and the so-called Doha Round of trade talks collapsed.
Many suggest that illegal immigration is encouraged now just for the very purpose of generating downward pressure on wages. Virtually all agree that Globalization will have the effect of averaging out wages for unskilled workers across the planet. Both, of course, mean big losses for unskilled Americans. The effect could be mitigated and immigration pressure reversed if a rational farm policy at home were in place and trade and development assistance policies that encouraged rather than punished agrarian economies abroad were the standard. In theory everybody can be made better off from trade. In order for that to happen, however, the gains have to be distributed to everybody. When corporations control the transactions, no distribution is made, the gains are captured by the corporate sponsor.

The Washington Consensus and claims for Globalization are easily discredited, both theoretically and by the tragic empirical evidence. Where it has been tried, it has not worked. The decline following the free market shock therapy in Russia, the failures (and conditions which led to them) following the Asian currency meltdown, the suffocation of Latin America and Africa, all followed from Washington Consensus prescriptions. The expansion of the U.S. following the Second World War, the resurrection of Europe and Japan, and the more recent successes in China, India, Singapore, Malaysia, and elsewhere all rejected the same nostrums. Such policies thrive not by virtue of intellectual consistency or results on the ground, but undoubtedly because they support the Establishment, the Corporate Oligarchy. In that view and from an American imperial perspective, the impoverishment and dependency of nations is not necessarily a bad thing. The free market regime of the Washington Consensus has not worked because it cannot work. Economies do not behave as they are imagined to. Meanwhile the opportunities latent in the underdeveloped world (cited in later chapters) that could be released by Demand Side policies are foregone, including big new markets for American goods.

An alternative path to development. Environmental imperative meets global poverty with the program of emerging nations building their economies using green energy and small footprint development. If new industrial economies follow the old dirty energy path being blazed by China, they will become part of a desperate global end game. These countries can be the laboratories of sustainable development. That effort should be assisted and rewarded commensurate to its value.

Invest in economies not plantations. The supply-side bias has worked no better abroad than it has at home. In thinking about global development it needs to be abandoned along with its disastrous consequences. The United States and advanced economies perpetrated a cruel hoax on the developing world when, through the IMF and other institutions, coerced countries into export-based, privatized economies. But when the U.S. and advanced economies came face-to-face with the same type of economic crisis, they abandoned the prescription of balanced budgets and strict privatization. Necessarily the credibility of the Western sponsors of the "Washington Consensus," has been destroyed. Investment that creates the foundations - in roads and schools and clean water - will build economies there as well as here. Other investment - in factories and plantations - is nearly always a mask for exploitation. Given an adequate platform, nations can devise their own economic success.

Before everything else, the debt of the Third World ought to be forgiven -- and without the restrictive structural adjustment policies (SAPs) the IMF shackles to them.coerces from these poorer nations, shackles to unworkable economic designs. A stable representative government that has legitimacy with its people ought to be the only criterion for forgiveness. Developing nations taken together now spend $13 on debt repayment for every $1 they receive in grants. This debt is often a legacy of oppressive governments or corrupt lending practices. Ending it will create immediate demand for products and a means to begin. Continuing it will continue an injustice that eats at the roots of global prosperity.

Reform trade to protect agrarian economies. Globalization has unfortunately meant decimation of the agrarian economies of many of the Latin American and African countries. Agriculture is the dominant industry of most poor nations. Trade agreements must recognize this and protect agricultural development and diversification. In fact, they most go further, and realize than Agriculture that is not resource- or capital-intensive is in line with the needs of the future, and encourage it. Unfortunately, Globalization has meant simply a new colonialism, in which protection and subsidies are allowed for the wealthy and eliminated from the poor. The advanced countries could be exporting education, utilities, roads and machinery, rather than eviscerating the earning power of near-subsistence farmers. Immigration experience demonstrates that , in a very real sense, we will export the means of development and import products or we will import the people.

It is a cruel myth that economic activity is orchestrated by natural laws and revolves in a manner to which governmental policy always amounts to interference, a reduction in efficiency, a distortion. Economic affairs have evolved to favor the powerful in every society. When the people are powerful, as in a free democracy, they are favored and the economy does well. When not, financial rewards cant to the dominant institution or group and economies sputter or stall as social tensions rise.

It is, then, not populations that must bow to the natural laws of an economic galaxy. Instead the institutions, rules and incentives of the economic galaxy must be ordered to benefit populations. In our real and present case this may allow the pursuits needed for survival of society.

2009-08-06T07:33:00.000-07:00

Chapter 11
Public Goods and the Commons

Public Goods

Demand Side as elaborated upon here makes a special point of Public Goods. They are one of our "big words." Public Goods account for an immense portion of the well-being of our citizenry, and at the same time generate immense wealth to private economic actors.
A brief definition: Private goods - those which our society creates and consumes in such abundance - are marked by two primary characteristics. They are excludable and they are depletable.

Excludable means that to a greater or lesser degree the use or enjoyment can be limited to a person, household, or group. This is important. My use of an item excludes your use. Autos, houses, durable goods, food, electronics, air travel, and on and on.
Depletable means the benefit of the product can be limited, focused, monopolized. The entire economic benefit is consumed, or can be consumed by the buyer, wearer, user, and so on.

Public Goods, by contrast, are to a greater or lesser degree not depletable and not excludable. For example, a road is not depletable: No matter how many cars use a road today (and recognizing that there are limits to everything) cars will be using it tomorrow as well. It is not excludable. Who will be able to collect a toll for every road, or collect the cost of the service if the road is plowed free of snow?

Not being depletable means in their own way Public Goods are the goose that lays the golden egg. Not being excludable means the private market is unable to isolate the benefit sufficiently to be efficient producers of Public Goods. The private market requires payment in an amount approximating value; such a payment which will not be forthcoming if one party does not monopolize the benefit and enjoy the predominant value of the good.

When one party does not monopolize the benefit, it is difficult for the private market to exist. Remember, the market itself consists of nothing more or less than the moment of purchase and sale. The classic example is national defense. If the nation is defended from attack, I am defended, even if I do not choose to pay for the service. I am defended because my neighbor is defended. This is known by the technical term, the free rider problem. This is the downside of not being excludable, and it is the major reason that we have a universal coercive means of financing - taxation. There ought to be no free riders on Public Goods. The cost of the road, national defense and education ought to be shared by all, since their benefits are shared by all.
Public Goods as exemplified by roads are obviously a good deal. MacDonald's founder Ray Kroc once asked his protégé, "What business am I in?" The unsurprising answer was, "The restaurant business." "No. The Real estate business." The value of his fast-food outlets depended on their location. The success of his fast-food outlets depended on their locations. The value of a location depended on the access from streets and roads. A new highway or bridge may increase property values immensely. In rare instances part of the gain may be captured for public use. Most often it becomes wealth to private landowners.

Does the same sort of benefit attend other Public Goods, such as, say, education? Public education has an immense value, but that benefit is not monopolized by the individual. An education not expressed in family, community, or workplace is essentially valueless except as a source of amusement (or edification, to the more serious) to its owner. But when it is expressed in job, earnings and spending, community and family, its benefits extend far beyond the individual - to the employer, the children, the neighbors and fellow citizens, and to the providers of goods and services. This benefit can be very great. The diffusion of beneficiaries is matched by a diffusion from the spectrum of time over which an education is used. A lifetime. It is easy to see that an education's value is not excludable, or in a sense, depletable.

The same analysis can be applied with similar results to other Public Goods, such as national defense, public safety and public health. The total return is far greater than the cost or than the benefit returned to the individual, but it is impossible to isolate and capture that larger return in a transaction. The market requires a relatively simple transaction to operate efficiently. It cannot deal well with multiple beneficiaries or variable benefits or extended or uncertain periods of time. A good which returns enormous benefits over costs will not be produced by the market unless the purchaser commands enough of the benefit to match the seller's price.

A clear understanding of taxation and the value of Public Goods is essential to remove the obstacles to growth. Taxes are simply the means of purchasing or financing Public Goods, in the same way mortgages finance houses. The great success of the anti-government Right Wing in the United States has arisen from their ability to separate taxes from the goods they purchase in the minds of the electorate. Taxes have become an evil in themselves, the fangs of a vampire government, money which disappears into the bloated bureaucracy, a theft of the necessary incentives to private activity. This is nonsense. If you want a car with a smooth ride, you get a car loan for a BMW or Lexus. If you want a road with a smooth surface, you pay taxes. Nobody can buy a road with a credit card, any more than it would be appropriate for the government to purchase a BMW for an individual. The hysteria associated with taxation is little more than political charlatanism, and is not borne out by either rational thinking or experience.

Instead of a clear understanding, however, a double-think has occurred. Taxes are evil and the goods and services produced by government - one-third of all expenditures - are given. As if deposited by God or nature. In fact, taxes are the source of funding for Public Goods. Public Goods which have a high multiplier at the front end, being expenditures of government, and so stimulate economic activity. They often produce immense value over their cost and create wealth for many private economic actors.

The Commons

The Tragedy of the Commons is a problem that confounds solution. The archetypal Commons of Scotland gave us this metaphor. Because all cattle had equal right to the resource of the common pasture, the Commons was overgrazed. Users had no incentive to personal responsibility. Because it was overgrazed, the Commons did not provide sustenance enough for healthy cattle. Thus the resource was overused and the users eventually were impoverished. The problem was solved by enclosing the Commons and giving property rights to the local lord. This captured the incentive to manage the pasture responsibly. Of course, this was hollow comfort to those in the community who now had no resource whatsoever.

The modern Commons - the air, the water, and other resources, in all their forms - resist enclosure. Even if enclosed, that is, controllable and leasable, the possibility of misuse by the lords should give us pause. For example, the airwaves now under control of media moguls have not produced the highest good and often seem to have invited predation of the common mind. Demand Side solutions exist, but require a public ownership of the resource that does not now exist.

Understanding economic goods

We cannot accept mere activity as a measure of health, but this "activity" is precisely all that GDP measures. Whatever bubbles up is not always good. The very acts that destroy the future - wars and profligacy and destruction of the environment can rank high on a "growth" scale that is measured in a "product" that is merely monetized activity. In the measurement of GDP, a home is the equivalent of jail, nutrition the equivalent of alcoholism, education the equivalent of pornography. "Goods" and "bads" are counted equally. More accurate measures of economic and social health exist, and we will look more closely at the measurement of economic goods in a later chapter.

Examples of those public goods:

Rail. Because our current private goods automobile-centered transportation consumes so much space and so many resources and produces planet-strangling pollutants and greenhouse gases, it is a good demonstration of the private goods to public goods move we need. In rail we have the opportunity to replace imported oil with domestic infrastructure, reduce pollution, free physical space for other uses, and create a stable jobs-producing industry. Unfortunately, the public good of rail is captive to the rail industry which cannot capture all its benefits and so seeks to maximize its return on capital and minimize its investment by concentrating on modular, long-haul and bulk freight, rather than passengers or short-haul freight that would reduce or replace freeway expansion.

New non-polluting fuels. Methanol, fuel cells, and other advances into a clean energy future can be developed by private corporations for profit if the government will only guarantee a market for the product. This is called "advance commitment procurement" and involves no public expenditure on the development of products, only the commitment to buy such a thing if it is developed. At a specific, not open-ended price. Or, as California has done with its pollution restrictions, the market can be described and those who want to participate in it have to meet the guidelines. The catalytic converter and tens of billions of dollars in private R&D have been generated without a dime of public money by these kinds of guarantees.

Clean Energy and Conservation. The green energy sources are essential, and developing the technology for clean energy can give Americans the growth industry of the next century. This is more well described by others. At the same time, simple conservation and building retrofitting is a no-brainer in terms of financial payback. The government need only provide a financing mechanism that can capture the savings and private contractors will do the work. Such activity, of course, provides a big new market for conservation in housing, urban design, and building products. Again, the markets can be produced by both incentives and disincentives.

2009-08-05T08:51:00.000-07:00

Chapter 12:
An Anecdotal History of Post-War America

"The political problem of mankind is to combine three things: economic efficiency, social justice and individual liberty."
- John Maynard Keynes

The tendency for economists to discuss issues in the abstract and hypothetically is a major flaw. The simplifying assumptions necessary to make Classical economics functional are precisely the mechanisms that remove it from relevance and deliver it into the convenient world of the imaginary. Economics arises in the context of historical events. This is a point we have belabored. This chapter offers a sketch of that history from the perspective of the presidency.

needs a place

The direct look Galbraith took at the American scene contrasted starkly with the approach taken by the Conservative economic schools (Monetarist, Neoclassical, Neoliberal, Supply Side schools). These began and ended with neat and simple theory and assumed away inconvenient reality, ignoring the power and even the presence of the Corporate Oligarchy. The resulting world did not exist, but at least it was marked by healthy free competition, market discipline and vigorous growth. The popularity of these schools derived from their political convenience, to their appeal to a resurgent conservative bloc, particularly after the Vietnam War and to eager sponsorship from the very corporations whose power they failed to acknowledge.

The Great Depression through World War II

Demand Side theory was formulated originally by John Maynard Keynes, who as we noted prescribed deficit spending to invigorate demand and draw the economy upward. But Keynesianism was applied in the United States before that theory was fully disseminated and certainly before it was validated by the war experience. The New Deal of Franklin Roosevelt was Keynesian almost as a byproduct of being compassionate. The hungry, impoverished and unemployed - not the strength of reason nor the elegance of theory - demanded these programs.

This is not to say that the answers of the New Deal were knee-jerk reactions. They were the considered responses of many of the ablest young minds of the era, talented people who turned spontaneously to the problems of the Depression as the grand challenge of the day, much as space was the great challenge a generation later, or the environment is the vital challenge of today. Many of these young economists assembled in the federal Department of Agriculture under Rexford Tugwell, for example. Others found work in the offices of populist elected officials, such as Senator Richard Wagner of New York. Still others located in universities, such as Harvard and the University of Wisconsin, which had freed themselves to some extent from the hegemony of Classical economics.
The confluence of motivated talent and manifest need resulted in a series of measures, among them the Social Security Act, unemployment insurance, the Work Projects Administration, the Civilian Conservation Corps, which increased spending and were financed by borrowing. These remedies of necessity for an impoverished nation were also the deficit spending of Keynes' prescription.

The Social Security Act began sending retirement checks within two years of its enactment, a feat made possible of the pay-as-you-go financing which has in recent years drawn so much criticism. This was a period of desperate want among many older Americans, a want which echoed through whole families. There was no time to wait for investments to mature. Indeed there were no investments to mature in the black days of the Depression. So the stock-based proposals of the current day were not then serious options. The Social Security Retirement Act thus freed children from the sometimes grim duty of providing for parents and allowed them the opportunity to develop themselves and their prospects. Previous to this Act and in many other nations continuing to this day, old age security depended on the number and loyalty of one's children.

Unemployment Insurance is the archetypal counter-cyclical program. So long as employment tracks economic health, benefits are paid out, with their consequent demand stimulus, when unemployment is a problem and withdrawn when the economy heats up. Unemployment Insurance began as Title III of the Social Security Act of 1935. Title IV of that Act was Aid to Dependent Children, another joint federal state program. This provided direct relief to many families abandoned by husbands and fathers during the Depression. Today it is the central element of what is sometimes pejoratively known as Welfare.

The Works Projects Administration was created by direct presidential order in 1935 and employed millions of people. The WPA was a presence in virtually every locality. The Civilian Conservation Corps was created in Roosevelt's first one hundred days and likewise employed people, predominantly young men, in thousands of communities. These were direct employment programs, and they stimulated demand immensely. Those wages not immediately spent by program participants was invariably remitted to their families. The multiplier was very high.

With the advent of war, the conceptual tools of Keynesianism and the economists who used them in the New Deal moved directly from the problems of Depression to the problems of mobilizing the war effort, controlling prices, financing new plants and balancing output.   The war economy was managed with an efficiency that matched or surpassed that of the military machine.
In sum, Keynes in Britain and the New Dealers in the United States provided the economic remedy to the Great Depression. Theory and practice was ratified by the experience of World War II. Keynesianism emerged as the dominant system in the US and Europe following hostilities. It would guide public policy for the next twenty-five years.

John Maynard Keynes, a British economist and diplomat, truly was the savior of market capitalism in the last century. Those who have heard of Keynes may be surprised, or even offended, to hear him described her as the "savior" of capitalism, but it is no exaggeration and not even controversial among most economists. Keynes operated in the context of the Great Depression, the deepest and longest, but by no means the only, economic crisis that afflicted pre-World War II capitalist countries. But as we've seen, it was not primarily Keynes' theory that brought on the New Deal. It was, however, Keynes' theory that provided the means to understand the events of the Depression and the following war. When results followed as predicted, it propelled Keynesianism to the fore.

After the war a period of unprecedented expansion began, anticipated by few, but eventually fathered by many. The world's economy was dominated by the United States. Even five years after the war, in 1950, with little more than six percent of total population, the U.S. economy was greater than the entirety of Europe and Scandinavia. It was five times the size of the Soviet Union. Economically the world was composed of 40 percent United States of America and 60 percent everyone else.

The wholesale destruction of Europe and Japan left U.S. industry largely unburdened by competition from other nations and blessed with enormous need for its product. Confidence in New Deal economists and Keynesianism, or a fear of return to Depression, gave rise to the Employment Act of 1946. The Act codified the responsibility of federal government to intervene and direct the economy under the leadership of the president for the purposes of full employment.   The Act, for the first time, recognized the power of the government to affect economic outcomes by its use of fiscal policy - taxing and spending - and monetary policy - interest rates and money supply. The Employment Act gave the president the mandate to use policy to effect "maximum employment, production and purchasing power."

"Purchasing power" in the Employment Act was added late in negotiations, being a euphemism for price stability. The concern for inflation later would grow to overshadow full employment. This conflict between conservative Republican concern for price stability and Keynesian and Democratic concern for employment played out in the maneuvering leading up to passage of the Act, as it would over and over again in the decades to follow and until its provisions were reversed by neglect.

Aside from the new role for government in directing the economy, postwar America was different from prewar America in other respects: the federal government was four times its former size, the United States held geopolitical dominance over the world, Protectionism although not dispelled completely had begun an inexorable turn toward a free trade bias, and expectations of people and business were of a level higher than previously.

Truman

Harry Truman, "the man from Missouri," and later "Give 'Em Hell Harry," rose to prominence as a U.S. Senator leading investigations of wartime waste, fraud and corruption through the Truman Committee. Tapped by Franklin Roosevelt in 1944 to run as vice president in place of Henry Wallace, Truman ascended to the presidency in 1945 on Roosevelt's death. It fell to Truman to traverse the gauntlet of transition from war to peace. First inflation, as industry scrambled to retool capacity for consumer goods and consumers released years of pent-up demand, demand further enabled by the innovation of installment credit. Then employment, as seven million men under arms returned to the work force. Finally, a new geopolitical reality, as the U.S. emerged into a position of global superpower and began the first mapping of the Cold War. Truman and his chief economist Leon Keyserling are not sufficiently appreciated for their courage and insight in this critical time. By the path they chose through these obstacles, no two men are more responsible for setting the foundation for the growth and stability of the next twenty-five years and an unprecedented material prosperity.

Keyserling was the second chairman of the Council of Economic Advisers, an office created by the Employment Act, and probably the most influential of any. Keyserling's approach was more New Deal than Keynesian. He propounded an economic "partnership" between government, labor and business. Targets for development, targets for production and targets for inflation were, in Keyserling's view, to be a shared responsibility under the basic purpose of full employment of labor and capital. Needless to say, this view was not adopted by all, but Keyserling and Truman deserve credit for growing the economy through the postwar inflation, against vigorous opposition, without substantial unemployment.

In particular, when the inevitable inflation began to rise in manufactured goods (but also in commodities, particularly farm commodities), many called for higher interest rates and government action to "cool off" the economy. Truman and Keyserling resisted that notion. Even though their preferred tool of price controls had been taken off the table by the business-dominated Congress, they continued to argue for growth, and their determination won out. The price surge broke. The boom cycle ended in the context of dramatic federal downsizing, and the country appeared headed now in the opposite direction, toward the universally feared return to Depression. Instead the economy stabilized and began to grow again. Truman immediately claimed credit for this by virtue of, among other things, his farm price supports, which as he said, provided a floor of demand.

In the most celebrated political comeback in American history Truman won reelection in 1948 when he ran as an activist president against the "Do Nothing Congress." His subsequent assessment of the threat of the Soviet Union and the strategic capabilities of the United States, developed in large measure by Secretary of State Dean Acheson, defined the era to follow. Anticipating the rise of the Soviet Union, the National Security Council explored the Cold War in advance. A top secret memorandum, NSC-68, outlined the threat and America's ability to respond. The key opposition to a proactive America centered on the contention that U.S. economic strength would be drained by an aggressive build-up. Keyserling's analysis of the nation's economic capacity refuted the contention. The experience of World War II was fresh enough evidence in support, and the Korean War which forced Keyserling's analysis into practice and bore him out.

During the darkest days of the Korean conflict, in one of the most unmarked and unremarked-upon events in American economic history, the Federal Reserve Board ("The Fed," America's central bank) wrested from the President and the Department of the Treasury unilateral control of monetary policy for itself and indirectly for the benefit of lenders. Prior to the so-called "Treasury Accord," the Fed had been independent only in the sense that other oversight boards and commissions (Federal Communications Commission, the Food and Drug Administration, etc.) were independent. That is, although not associated with a particular Executive department, they took policy direction from Congress and the President. During this time the Fed, obviously, worked closely with the Treasury. But as Truman's support sank in a tide of bad news from Korea, and then in the aftermath of his highly unpopular recall of General Douglas MacArthur, closet negotiations produced the agreement which gave the Fed its unilateral power, the Treasury Accord. William McChesney Martin, a key negotiator within the Treasury because of the hospitalization of the Secretary of the Treasury William Simon, earned a long tenure as chairman of the Fed in the conspiracy. (As well as the sobriquet of "traitor" from Truman, delivered personally on a chance meeting between the two some years later.)   Monetary policy soon shifted its focus from keeping interest rates low and stable (in part to reduce the burden of the war debt on the federal treasury) to a concern for the interests of the banking community and maintaining price stability. Two decades later, Keyserling estimated the cost in excess interest to be in the hundreds of billions of dollars. That figure was given prior to the great run-up in debt of the Reagan Administration and would be well into the trillions today.

Truman is regarded far more positively today by the public and historians than the day he left office.   Economically, he holds the distinction unique among postwar presidents of producing a net federal budget surplus, this in spite of financing the Korean War on budget. The Truman years were splendid in terms of low unemployment, high growth and strong corporate profitability. In the next chapter we explore the economy's performance using statistical measures, by president, and we will find Truman at the top of the scorecard.

Eisenhower

General Dwight D. Eisenhower was elected in a landslide in 1952 over Democrat Adlai Stevenson, the first Republican president in twenty years. Eisenhower entered the Oval Office as an administrative genius, a man who had masterfully managed the European Theater during World War II and the one who could bring skill and sanity to civilian government. Ike left eight years later as the man too small for a big job.

Eisenhower saw government as a management problem, and went to the rivate sector looking for good managers. He appointed a long line of corporate officers to government posts, including the notorious Charles E. Wilson from General Motors as Defense Secretary. Wilson produced an uproar with the statement, somewhat apocryphal, "What's good for America is good for General Motors, and vice versa." In this vein, Wilson presided over the National Interstate and Defense Highways Act, a national defense strategy that produced the interstate highway system, the largest government-sponsored construction project in history. None benefitted more than General Motors and the auto industry. One can only speculate as to the different America that might have emerged from investment of similar magnitude in rail transportation.

Virtually all economists at the time - including Eisenhower's own chief economist Arthur Burns - were Democrats, so the Conservative flag was carried forward by Republican political operatives, notably Senator Robert Taft. Eisenhower alienated Taft and the Old Guard when he proposed a budget in 1953 that did not balance and later when he refused to lead the effort to roll back the social programs of the New Deal.

Eisenhower's alternative "New Republicanism" was itself rejected, however, first in 1956. Although he beat Stevenson in a rematch of 1952, Republicans lost thirteen Senate seats and another forty-nine in the House. It ushered in an era of seemingly permanent Democratic majorities on Capitol Hill.

In Eisenhower's farewell address to the country in 1960 he spoke with feeling about the dangers of the "military-industrial complex," the conspiracy of interest between the Defense Department and the industrial suppliers of technology and arms. This was not a late discovery of his. Odd, perhaps, for a former general, and certainly unexpected by many prior to his election, rooting out waste in Defense was nonetheless a strong theme of his presidency.

Kennedy

Of all presidents, John F. Kennedy was the most engaged with his economic advisors. He assembled a brilliant group, with Walter Heller, James Tobin and Arthur Okun in the Council of Economic Advisers and adding John Kenneth Galbraith and Paul Samuelson in unofficial roles.

Of all presidential fiscal policy precedents, none has been more problematic than Kennedy's 1963 income tax cut. Designed by his Keynesian advisors to reinvigorate a slowing economy, it worked. But it was deficit spending, so Conservatives pilloried it mercilessly. Since that time, hearts have changed, to say the least. The Kennedy tax reduction has become a model, or at least a supporting case, for every Republican president since. The extremely modest scope of Kennedy's tax cut has been expanded by a hundredfold into the hundreds of billions of dollars per year now exacted for "stimulus" sake under George W. Bush. Such an ongoing stimulus, of course, is not only counter-intuitive, but counter-productive.

The most dramatic economic action on Kennedy's watch, however, was the 1962 showdown with Steel. Today the management of inflation has been implicitly assigned to the Fed, which manipulates interest rates in anticipation of or reaction to price pressures. Kennedy and all the presidents prior to Reagan met inflation in the field with one or another direct program. Kennedy and his advisors employed the tactic of directly influencing product and labor prices through a program of wage and price "guideposts," not mandatory, but heavily suggested targets. It was an incomes policy similar to that envisioned in Keyserling's partnership between business, government and labor.

Crisis occurred in 1962. After particularly difficult negotiations in the steel industry, steelworkers' unions had grudgingly accepted a contract in line with the Kennedy guideposts. U.S. Steel's president then announced a raise in prices above the guidepost level. Seven of the biggest steel companies followed suit. Kennedy's response to the betrayal of the guidepost policy was volcanic. "My father always told me that businessmen were sons of bitches," he was reported to have said. "But I never believed it until now." Every pressure possible was brought to bear on the offenders. Federal contracts were cancelled with the offended companies and handed to Republic Steel, the one company who had not raised prices. Inspectors and regulators showed up on their doorsteps. Investigations by the Federal Trade Commission and Justice Department (under Robert Kennedy) were launched. Seventy-two hours later Steel backed down.

Kennedy was assassinated in September 1963 in the most traumatic national event prior to 9-11. His programs were taken up by his vice president Lyndon Johnson. Although the psyche of the nation was shaken, its economy continued upward.

Johnson

In Lyndon Johnson rare parliamentary skill was matched with a vision, the vision of the "Great Society," an echo of Franklin Roosevelt's new deal. The Great Society programs ranged across the challenges of urbanization, education, health care, poverty and equal opportunity. These were programs that envisioned a government active in reducing poverty, discrimination, and the financial insecurity of its citizens. Some elements, notably the Medicare program, survive.   Others, as well as appreciation of the domestic policy aspect of the Johnson presidency, have been washed away, because at the same time Johnson prosecuted a costly and divisive war in Vietnam.

Johnson continued to wield the wage-price guideposts to address inflation. In 1965 he threatened to dump commodities from the government's stockpiles on the market, which forced producers of aluminum, copper and wheat to moderate price increases.
Ironically, it was Johnson who had coined the phrase "guns or butter" a decade earlier to describe Truman's military build-up and simultaneous "Fair Deal" programs. Ironic because "Guns and Butter" was the phrase condensing the desire to have it both ways, war and domestic programs, that was used to stigmatize Johnson's own economic policies. It applied to the desire to have it both ways, war and domestic programs. A super-employed economy meant high factory utilization and record low unemployment, powerful growth, but also price pressures: the feared inflation. Although inflation in Johnson's tenure was mild by comparison to that of the subsequent two decades, alarm was high. Johnson responded with a 10 percent tax surcharge applied in midyear 1968, designed expressly to reduce demand and price pressure. Johnson was the last president to make a tax increase a central point of his economic policy.

The Depression and World War II served as historical tests for Demand Side. Peace brought more ambiguous economic events - inflations, prosperity, industrial expansion, social programs, supply shocks - and on a scale not before seen. The mild Johnson guns and butter inflation was taken by eager Conservatives as a failure of Demand Side. The analytical tools and biases that had failed in the Depression were dusted off and trotted out to meet the new problems. Fortunately for the country at the time, the problems were not severe enough to embarrass the failure of the Classical tools. Unfortunately for the long term, the absence of embarrassment only gave credence to the convenient tenets and allowed a full resurgence later under Reagan.

Bitter over criticism of the Vietnam debacle, Johnson refused to stand for reelection in 1968. His vice president Hubert Humphrey secured the nomination in a tumultuous and divided convention. The election would be held in the context of seven years of uninterrupted economic expansion during which GDP had risen nearly 40 percent, but in the campaign economics took a back seat to an unpopular war, crime, and a perceived decline in personal morality during the 1960s.

Nixon

Richard Nixon bested Humphrey. Nixon used the much discussed inflation as a backdrop for sermons against the Great Society. He did not offer a remedy, however, believing in private that the peace dividend from the end of the war and high growth seemingly embedded in the economy would ease the problem without sacrifice.

The economy cooled, but inflation remained stubbornly high. Balance of payments deficits (again mild by today's standards) fueled alarm. During a weekend retreat at Camp David the weekend of August 13-15, 1971, Nixon and his economic brain trust produced one of the most dramatic and least successful economic policies of the postwar era - the Wage-Price Freeze. They were very popular initially with the public, but ultimately the ramifications of price controls absent the wartime willingness to personal and communal sacrifice were chaotic. Evasion of controls was rampant, and the explosion of prices after the inevitable lifting of the freeze produced more uncertainty than ever. Disorder returned when against the advice of his advisors Nixon reinstated the freeze in 1973.

Between those two years was the election of 1972 and the first edition of the "political business cycle." When Nixon had first run for president in 1960, most blamed his loss on a weak performance in the televised debates with Kennedy. Nixon himself blamed the sickly economy he had inherited from Eisenhower. So in 1972 Nixon sought to create economic good times in the period leading up to election day. He timed government outlays strategically and elicited interest rate accommodation from the Fed. Nixon's strategy worked well and has been employed by every incumbent president since, with the exception of Jimmy Carter in 1980.

In 1973 the phenomenon that combined high inflation with high unemployment emerged. Stagflation. Although it occurred in the middle of a Republican administration, stagflation was widely used to discredit Keynesian economic analysis. This was done by imputing to Keynes the contention that inflation and economic recession would not coexist, partly because the guns and butter explanation of Johnson's inflation did not fit, and partly in a simplistic response to the relation between inflation and unemployment typified by the so-called Phillips Curve. This notion of a necessary trade-off between inflation and unemployment is not particularly Keynesian.   Stagflation's roots likely lie instead in the rise of OPEC and the first oil price shock in 1973. The price of oil rose from $4.11 per barrel in December 1973 to $10.11 the following month and trended upward with inflation in the years to follow.   This initially led to long lines at the pumps, as the Nixon freeze prevented supplies from being rationed by the price mechanism (higher prices discouraging demand). Oil prices soon seeped into every nook and cranny of the economy, first by drawing up the prices of other energy sources and then by sifting these prices into production and transport costs.

In another decision reached in the 1971 Camp David retreat, Nixon ended the convertibility of the dollar to gold. This " taking the dollar off the gold standard," or "closing the gold window," effectively ended the world's last stable exchange rate regime, a regime, known as "Bretton Woods" for the New Hampshire town where world finance ministers negotiated it in 1944. Nixon's move allowed the dollar to float against other currencies, a move intended to avoid the need for capital controls as Johnson had used, to keep capital from fleeing to more attractive currencies. It worked for that purpose in 1971. Since then, the resulting instability of exchange rates has proven, to put it mildly, very problematic.

Ford

Nixon resigned under the Watergate cloud in August 1974. His running mate Spiro Agnew had resigned a year earlier under bribery charges. Gerald Ford, an appointed vice president, thus became the only unelected president in American history.

Ford inherited an administration whose lines of governance had been unraveling for more than a year as a result of Nixon's obsession with salvaging his political career and legacy from the Watergate scandal. The economy was struggling with stagflation and the absence of clear policy direction.

Ford appointed Alan Greenspan, later long-time Fed chairman, as chair of his Council of Economic Advisers. Their approach cannot be described as clear or aggressive. Emblematic was the WIN lapel button - "Whip Inflation Now." The button and the Ford policy were minimal in effect. The economy did pick up late in Ford's two-year tenure, but it was too late for his election chances.

Carter

James Earl Carter, "Jimmy" Carter, was elected as an outsider to the Washington political machinery. Impeccable in character and sincere in his efforts to be trustee for the common person, Carter was not sophisticated economically. But he recognized immediately the central importance of oil. Oil prices had doubled between 1973 and the time he took office in 1977, and US dependence on foreign supplies was growing inexorably. Early in his administration, Carter attempted to mobilize public will to address the problem, which he defined as "the moral equivalent of war." The 55 MPH speed limit imposed on the nation's highways saved immense amounts of energy, but the public was more annoyed than motivated. Carter's effort was lampooned by its acronym MEOW and pronounced ineffective.

The Democratic Congress was sympathetic to the efforts to reduce oil consumption, but at the same time frustrated with the administration's obsession with inflation produced the 1978 Humphrey-Hawkins Full Employment Bill, an amendment to the 1946 Full Employment Act. It sought to balance inflation fighting with efforts to spur employment and growth. The bill set out procedures to coordinate actions by the president, Congress and Federal Reserve, and imposed specific goal-setting requirements.

Humphrey-Hawkins passed into law, but was sabotaged early on when he Fed under Paul Volcker adopted a completely independent tight money policy. After the election of Ronald Reagan in 1980, the procedures and principles prescribed in Humphrey-Hawkins were largely ignored. What was intended to resurrect the Keynesian energy of the Employment Act became little more than a reason to footnote official memoranda.

Under Carter another tack was taken against the winds of inflation. Deregulation. The concept of deregulation was to reduce regulatory obstacles to free prices and let competition bring them down. Deregulation appealed to many on both sides of the aisle, and was later a precept of Republican policy. Its initial impetus came from Carter's chief inflation fighter Alfred Kahn, who brought it in from his experience in utility economics. The idea appealed to Carter, and to many on both sides of the aisle. Its effectiveness against inflation disappointed, but in freeing corporations from government oversight, it excelled.

Carter's last year in office was heavily burdened by the Iran hostage crisis. His economy was burdened by the consequent embargo of that country's oil. This second oil shock, seeing prices rise from $15 per barrel in January 1979 to $32.50 at the end created an inflation by the same dynamic as the 1973 OPEC oil shock. Believing inflation to be more important than economic expansion, even in an election year, Carter did a poor job managing the political business cycle. Unemployment rose, frustrating and enervating traditional Democratic constituencies. Taken over his full term, economic growth was moderately strong. But the last year was the second of only two years of negative growth under Democrats in the postwar period. Carter was defeated by Ronald Reagan.

Reagan

Twenty minutes after the completion of Ronald Reagan's inaugural address on January 20, 1981, the 66 American hostages held in Iran were released. The most egregious scandal of Reagan's administration, by possible coincidence, also involved Iran, being the sale of missiles to that country to finance terrorist guerilla bands in Nicaragua.

A chapter in Herb Stein's book Presidential Economics is entitled, "The Reagan Campaign: The Economics of Joy." It is followed by a chapter, "The Reagan Presidency: Encounter with Reality." As we have noted, Stein was chief economist to Richard Nixon.   Stein claimed to have authored the phrase "supply side" himself in 1976, but disavowed support for the official Reagan economic theory. Few economists in 1981, in fact, viewed Supply Side as a serious economic position. Supply Side promised higher growth with lower taxes and no sacrifice to fiscal integrity. It was intoxicating as a political program, and was a direct precursor to the Bush tax cuts twenty years later. Both presidents promised prosperity they did not deliver and delivered bonus sized benefits to wealthy Americans financed by federal deficits.

The Reagan Recession of 1982 was the deepest economic slowdown in postwar history. Double digit inflation was nearly matched by double digit unemployment. Poverty skyrocketed. Businesses and banks failed at record rates. "The homeless" became a descriptor for a large tribe of Americans. The manufacturing sector began its demoralizing decline. Corporate profitability entered a decade of anemia. Reaganomics led directly to the biggest federal deficit in the postwar - 6.0 percent of GDP - in 1983.
It was under Reagan that fiscal policy was permanently divorced from the inflation battle. Fiscal policy - taxing and spending - was given over to the Supply Side charade that tax cuts would actually lead to more tax revenue and to a vigorous peacetime military build-up. Neither tax cuts nor increased spending were good news for inflation, so inflation became strictly an economic issue and was shunted to the Fed and its chairman Paul Volcker. The Fed's chosen tools of monetary policy. Monetary policy consisted of interest rates and - most importantly in the Monetarist Era - the supply of money. Volcker had imposed money supply restrictions in the context of the oil shocks of the Carter years. He continued it through the first years of Reagan.

Monetarism promised that by reducing the amount of money in circulation, prices would painlessly and immediately fall. It was, unfortunately, not prices, but economic activity and employment that fell. Monetarism as espoused by its chief promoter Milton Friedman was a direct descendent of the fallacy called the "quantity theory of money." The Monetarist reasoned that prices could be kept down if the amount of money available were kept down. At first glance there is merit in this thought. If inflation is too many dollars chasing too few goods, then simply reducing the number of dollars should bring back a match with goods. (FN: The Truman alternative, as we have seen, was to increase the number of goods. The algebra for this is MV = PY, where M is the supply of money, V is its velocity, P is the price level, and Y is the level of output. eFN)

A little thought, perhaps stimulated by hard experience, demonstrates some of the difficulties with this idea. Another response to fewer dollars might be fewer goods, not lower prices, and this is what occurred in the Reagan Recession. Fewer goods, of course, meant lower employment, lower demand, and as the economy contracted, yes, eventually lower prices. Reducing the number of dollars also made dollars themselves more valuable and increased their price - the interest rate. Higher interest rates, of course, only further increased prices overall, since like energy, credit is integral to virtually all economic activity. A final major response to reducing the number of dollars was the creation of near-money, e.g., credit cards. This and other "credit money" eventually made the quantity of dollars a meaningless measure.

Thus the quantity theory of money was defeated again, if not in the classrooms at the University of Chicago, at least on the playing field. Although inflation did eventually come down, it was the grim task of lines of unemployed to bring it down. Reduced demand and stagnant economic activity broke the rise in the price of oil, and thus inflation. At the same time, the Fed permanently turned from money supply to interest rates as a means of combating inflation. (Interest rates are simultaneously the favored tool for stimulus, which created an awkward double duty that continues to this day.

The Volcker Monetarist experiment and the Reagan years contributed to a sea change in economic policy and economic reality. Reagan's first term marked the beginning of the de-industrialization of America. Manufacturing employment continued to decline even after the deep recession of 1982. With that decline, wages stagnated. In the ensuing quarter century there has been no increase in the real wage of Americans ("real" meaning inflation-adjusted).

Between 1947 and 1978, From Truman to Carter, real hourly wages rose 72 percent. Weekly earnings, which factor in the number of hours worked per week, rose 53 percent. Between 1978 and the start of the Volcker Monetarist experiment and 2006 (Reagan to Bush II), real hourly wages fell 5 percent and weekly earnings fell 10 percent.

Abetted by the Supply Side rationale, the federal debt exploded. By the end of his two terms, Reagan had tripled the debt to $3 trillion. Reagan's vice president and successor George H.W. Bush added more than another trillion by momentum. After a respite under Clinton, who added barely $400 billion in his eight-year term, the debt explosion continued under George W. Bush, who tacked on almost $2 trillion in his first seven years.

In the next chapter we offer some measures of economic well-being. "Net GDP" is one. Gross Domestic Product (GDP) measures the monetary value of all goods and services produced by the economy. Net GDP takes this figure and subtracts the federal deficit, the public borrowing which is used to maintain or inflate GDP. Just as it would not be proper to count a family's borrowing as earnings, so it is not proper to count the federal government's borrowing in a measure of its product. The Reagan years are in negative territory in Net GDP.

A connection between the federal deficit and the decline in manufacturing is direct. A high deficit means the government is bidding up the interest rate, the price of money, with its borrowing. The dollar climbs with the interest rate. A "strong" dollar means weak manufacturing, because goods are higher priced for no other reason than the currency in which they are denominated is higher in price. That is, an automobile made in the U.S. is more expensive than one made in Japan for no other reason than when the Japanese model is imported, the currencies that are the media of exchange give a discount to the yen. Thus the arrival of Toyota, Nissan and Honda and the departure of Chrysler, GM and Ford.

The Reagan Era witnessed a burgeoning of committees on "competitiveness," which became (depending on the bias of committee members) an opportunity for blaming unions or production management. Finally blame gave way to the understanding of the cost of the strong dollar. Reagan's Secretary of the Treasury James Baker orchestrated the "Plaza Accords" of 1985. Baker convened the finance ministers and central bankers of Germany, France, the United Kingdom and Japan at the Plaza Hotel in New York City to negotiate a reduction in the exchange rate for the dollar. Initial reaction from attendees was dismay that the U.S. demanded concessions from others without reducing its own enormous deficits, which most viewed as the cause of its problem. But they agreed to a process which brought the dollar down by 30 percent against major currencies over the next two years. This gave some relief to American manufacturing, but it was left to Clinton to address the root of the high dollar/high interest problem - the federal deficit.

Reaganomics proved that deficits do matter ... eventually. High interest rates and a ballooning debt in Reagan's first term brought on debt service (interest payments) that sapped the economy's strength in the second term and beyond. Debt service as a proportion of tax receipts has historically been a function of the interest rate, as Leon Keyserling observed in his critiques of the Fed. During the 1950s and 1960s the percentage of tax revenue going to interest payments hovered around 10 percent. Under Nixon and Ford it rose to 15 percent. AS the Volcker Monetarist experiment unfolded it ballooned from 15.8 percent in 1978 to 35 percent in 1984, where it remained through the high interest years of Reagan and Bush I, peaking at 39.4 percent in 1991. That is nearly four of every ten dollars in receipts going to service the debt.   Fiscal responsibility during Clinton's two terms and then an aggressive low interest policy by the Fed which began in 2000 have reduced this figure to near 20 percent today. Undoubtedly taxes expended for interest payments produce less economic benefit than taxes expended for goods or services.

Bush II
Reagan's vice president George Herbert Walker Bush followed him to power on the same anti-tax platform. "Read my lips. No new taxes." It was an echo of the "No new taxes," pledge Reagan had made during his debates with Walter Mondale four years earlier. Although both won their elections, and both men raised taxes subsequently, Bush's tax increases did not slide by unpunished as Reagan's had. Bush was lampooned by the press and made out to be the betrayer of the Gipper's legacy.

Reagan and Bush colored taxes with a shade of evil. Taxation became bad for the economy, in and of itself. This clearly disprovable contention rested on vestiges of Supply Side misconceptions and perhaps on a memory of the stimulus enacted during the Kennedy-Johnson years. The evil of taxation was asserted loudly in revival-like meetings and by Right Wing think tanks such as the Heritage Foundation. At its base, it was an assault on government. The hidden message to Conservatives was that taxation was necessary only if the liberal welfare state was necessary. This message was little different than that of Taft and the Old Guard in the 1950s. But this was not the message issued for general consumption, which left off any mention of cuts in government programs. Cuts were effected, however, by undermining revenues. And the cuts had the fingerprints of fiscally moderate liberals on them as a bonus.

Smaller government, the key objective of the Right, was not achieved by this indirect attack on financing, but only because Republican presidents expanded government spending themselves. Key social programs were squeezed, however, and others - notably health care for all - were kept in the can.

Another legacy from Reagan for George H.W. Bush was the need to bail out the savings and loan industry. High interest rates had been deadly to the "Thrifts," which had focused on long-term lending (mortgages) and depended on short-term borrowing. When short-term interest rates rose dramatically, they were caught in a vise. Deregulation began under Carter, but accelerated rapidly under Reagan. Accounting rules were reduce, and capital requirements adjusted. Fraud moved into the opening, and soon indictments and trials began to festoon the daily papers. Charles Keating, Michael Milkin and Herman Beebe were the most famous names to be indicted. Neil Bush, son of the president, was himself director of a Thrift when it collapsed. By 1990 nearly 400 major convictions had been obtained by the Justice Department in Thrift abuse. Bush and Congress closed ranks to bail out the investors. Although each account was insured up to $100,000, the promise of higher interest had drawn flocks of eager investors whose accounts exceeded this figure. The bailout continued a practice of de facto government insurance, employed earlier for Chrysler and Continental Illinois, and later for Long Term Capital. Estimates for the cost to the public of this de facto insurance in the case of the Thrifts ranged from $130 to $500 billion.

George H. W. Bush did become as a byproduct of the Gulf War the only president after Carter to preside over a year of trade surplus. The U.S. fought the war to evict Saddam Hussein from Kuwait, but it was the American allies - principally Germany, Japan, Saudi Arabia and Kuwait - who financed the war. Success put Bush's public approval ratings into the seventy percent range. But an oil price shock from the war contributed to a decline in the economy approaching election day.

Clinton

"It's the Economy, Stupid." It was a short, rude phrase to narrow the focus of staff, and it was posted over the doorways of staff offices along the campaign trail of William Jefferson Clinton's presidential bid. GDP growth under the elder Bush ranked dead last for all postwar presidents at 2.0 percent. Unemployment had increased during every year. Business was suffering. Clinton rode the issue of the economy into the White House.

In his first year, he packed his political capital into a program of deficit reduction. He sold it, barely, to a divided Congress. The 1993 Budget Bill increased revenue, reduced expenditures, trimmed the deficit, and required a tie-breaking vote by vice president Al Gore in the Senate to pass into law. Fed Chairman Alan Greenspan responded to the fiscal responsibility by easing off on short-term rates, and long-term rates began to fall. Millions refinanced their homes over the next few years at the lower rates, producing hundreds of dollars per month in new discretionary spending ability for millions of families. Stimulus impossible from further tax cuts was released into the economy, billions of dollars worth. This was the domestic side of "Rubinomics." Robert Rubin, head of Clinton's National Economic Council and later Treasury Secretary advocated fiscal discipline and open markets. This combination was to be the economic theme of the Clinton presidency.

Republicans lost no time in exploiting the tax increases of the Budget Bill in their "Contract with America." Of the ten points of the Contract, five called for tax reductions and limitations. The most specific advocated halving the capital gains tax and indexing it for inflation. Other points preyed on the notion of a runaway government, conflating taxes and profligacy, and ignoring the irony of preaching responsibility while not paying one's bills. The GOP took control of the House of Representatives in 1994 using the Contract as their principal campaign instrument. In the next budget cycle new Speaker of the House Newt Gingritch presented Clinton with Draconian program cuts. Clinton vetoed the cuts and set up an historic standoff during which the government twice shut down. Default was avoided only by creative use of trust funds to pay debt service. The episode narrowed the focus of the nation, however, from the general talking points of the Contract to the specific program cuts. The shutdowns proved to be a PR fiasco for the GOP, who were widely seen as reckless in their brinkmanship. Clinton's stiff resistance sparked his comeback to reelection in 1996.

The fiscal responsibility part of Rubinomics worked better than the push for open markets. The free flow of capital internationally, encouraged under Rubinomics, spurred a series of currency devaluation catastrophes. The largest occurred during a period spanning the last half of 1997 and the first half of 1998. The Asian currency crisis began with the meltdown of the Thai bhat and the "contagion" spread to Indonesia, South Korea, the Philippines and elsewhere. Capital had been flooding into the so-called Asian Tigers; it fled as quickly, since debt tended to be short-term and callable. Since debt was also typically denominated in dollars, the reduction in the value of the currencies against the dollar doubled or tripled the weight of the debt. Default and bankruptcies ensued. IMF relief schemes bailed out the lenders, not the borrowers. Debts were shifted to their governments. Bailout conditions required government budget austerities which further exacerbated the damage.

Financial crisis also visited Russia in the aftermath of free-market "shock therapy." Shock therapy was another Western treatment (from the Washington Consensus prescription book - see Chapter 6) that proved less than therapeutic. Russia under Mikhail Gorbachev and Boris Yeltsin was a nation emerging from the controlled economy of Communism. The remedy advised by the West was wholesale privatization and decontrol of prices. Before the shock was over, Russia had defaulted on its bonds. The default brought down the American hedge fund Long-Term Capital and nearly brought down the international financial system. The principals of Long-Term Capital had won Nobel Prizes in economics, but their mathematical models which counted on historical interest rate behavior to continue were contradicted by real world politics. Only luck and a consortium of financial houses brought together by the New York Fed averted a collapse of international bond markets.

These crises were little more than speed bumps in the inexorable expansion of the American economy, an expansion amplified in the rise of its stock markets. Ever advancing stock prices brought in more investors, and more investors pushed prices up. Nobody wanted to be left behind. Seasoned analysts' warnings did not prevent millions of people poured hundreds of billions of dollars into stocks and mutual funds. Each dip was a buying opportunity and each rise another reproach to the timid and contradiction to the naysayers. The "dot.com bubble," as it would later be called, increased paper wealth, which increased spending, which sent off a new round of growth. By 2000 the economic rise, without tax increases, had lifted the federal budget from record deficit to record surplus. Weakness in Social Security and Medicare trust funds was replaced by strength. A record number of consecutive quarters of growth seemed to have confirmed the arrival of a "New Economy" freed from the strictures of the business cycle.

Bush II

George W. Bush took office in January 2001. The longest peacetime expansion in postwar history ended in March. In September a terrorist attack on New York and Washington shattered the confidence of the nation. In its shadow Bush raised a new and bellicose foreign policy, and insisted on tax cuts and enormous budget deficits to replace the fiscal responsibility of the Clinton era. Hidden by 9-11 were other events more important in understanding the trajectory of the economy.

First, oil prices had favored Bill Clinton. High during the Gulf War, prices had fallen by the time Clinton took office in 1993 and fell even further four years later in the disruption around the Asian currency crisis.   Only near the end of his second term did oil begin to rise.   At $12 per barrel in February 1999, prices were $25 in November, and $34 in November 2000. In keeping with the political business cycle, Clinton tapped the Strategic Petroleum Reserve to keep prices down and assist Al Gore's presidential campaign. The move was muted, however, because Gore chose not to run on the strong economy. Oil moderated after the election and throughout 2001, but prices began to rise again at the outset of 2002 and did not stop until they reached $74.1 in July of 2006.

Second, long before 9-11 Alan Greenspan saw inflationary pressures in his statistical tea leaves and began ratcheting up short-term rates. The Fed raised its federal funds rate from 4.76 percent in June of 1999 to 6.53 percent a year later. The combination of high energy prices and high interest rates had its way. Inflation never arrived, but a stall in the economy did. Greenspan reversed course. The federal funds rate went into free fall and lost three full points to 3.77 percent over the next year. It halved again over the following twelve months, and kept dropping until the rate broke below 1 percent at .98 in December 2003. But it was too late Since that time the federal funds rate has risen again to 5.25 percent. This is still very low for times of such enormous fiscal deficits.

Third, the Bush tax cuts were not needed by the economy, but the weakness an national uncertainty following 9-11 provided an opening for their passage. During the campaign in 2000, tax cuts were a continual theme of the Bush camp, but using the slogan, "After all, its your money." With the economic downturn, the program did not change, but the rationale shifted. "For the sake of the economy." As under Reagan, hope for stimulus secured reluctant Democratic votes in Congress.

The economy had already begun to stall when the jets hit the Twin Towers, but 9-11 was employed as explanation for many ills, including the subsequent dramatic failure of the tax cuts to do what Bush promised. The cuts were Supply Side revisited, targeted to corporations and the rich, and so were ill-suited as economic stimulus. (See the discussion of the multiplier in the previous chapter.) It is not too simplistic to suggest that the Treasury received funding from the same sources before and after the tax cuts, but that afterward it was obliged to pay interest. Taxes from the wealthy were replaced by purchases of bonds by the wealthy.

A remarkable surge of incompetence and corruption also entered the federal government with George W. Bush, not restricted to the much-documented ineptitude surrounding the Iraq War, but evidenced as well in the aftermath to the natural disasters of hurricanes on the Gulf Coast, in the deregulation of energy traders that led to the Enron fiasco, and in dozens of other government mistakes of policy and practice.

Perhaps the most destructive example came in the area of energy and environment. Early in his tenure, Bush dismissed overwhelming world opinion and scientific evidence about global warming and withdrew from the multilateral Kyoto Accords. Later, as the tide of evidence and opinion overwhelmed doubt, there came no turn in policy direction, but as with tax cuts, only a change in rationale. It became not the weakness of the science, but the weakness of the economy which prevented anything from being done. The United States, the wealthiest society in the history of the world, could not afford its own survival.

The Future

The ability of the U.S. to borrow seemingly endless amounts of money at low rates has kept the economy from sinking, but basic economic weakness lies under this debt and crisis has only been delayed. As with global warming, shunting the weakness to the future will only complicate the solution.

Borrowing leads to an overpriced dollar and a trade deficit, as we've seen. This sets up conditions for a run on the dollar, a dramatic devaluation by market forces. The prospect for weakness in the dollar is extremely worrisome, for its implications on inflation and the potential for overreaction by the Fed. Most U.S. debts are denominated in dollars, so the effect of a devaluation would be to reduce the value of this debt. At first glance this might seem like a painless resolution, but resistance will be severe and depending on which way the pressure is released, damaging in any of a number of ways.

A second major crisis is in the queue hidden by the fiction of the unified budget," which has allowed the pass-through of Social Security and Medicare contributions into the operating budget. This politically expedient phonying up of the balance sheet undermines the financial health of these entitlements. As Baby Boomers retire, the trust funds will be asking for remittence on the bonds they have been given by the operating budget. At the same time the debt service will be growing from the current immense federal deficits. The debt-based financing which has replaced revenue-based financing comes with the price tag of interest payments.

A third, slower-unfolding crisis will arrive with the slow expiration of the housing bubble. Spurred on by low interest rates and speculative forces moving in from the stock market, housing sales and construction ballooned in the early 2000's. American households have incurred massive private debt. The inevitable peak will be followed by a long, possibly rugged decline. Demand strength from the wealth effect of housing has paralleled the experience of the stock market bubble of the 1990s, and has led to demand strength. This strength will leave and be followed by weakness, a reverse wealth effect as homeowners watch the values decline.

The Iraq War will, however damaging it may be to U.S. interests across the board may well mark a shift in the popular paradigm for economic action. World War II, the Korean War and the Vietnam War crystallized such changes. This change will likely be, as have the others before it, a reversal of direction, and may enable a return to social democracy from the Corporate Oligarchy practiced today. Such a turn would release immense productive capacity, because a social democracy has a higher demand function and can focus the energy of the economy more precisely and productively. The Corporate Oligarchy, on the other hand, is essentially set in its direction. Its dynamics allow little more than simple resistance to change for a steering mechanism.

Rationalizing health care insurance and delivery, reining in profligate consumption in favor of new forms of transportation and energy, a renewed commitment to education, and the retooling of the society to meet the challenges of the planet's survival are essential. They will bring growth. But they will have to be implemented quickly to be successful. Can the society can extricate itself from the current entrenched political powers in time? The answer to this question is the verdict on the society's survival.

2009-08-04T09:14:00.000-07:00

Chapter 13:

Economic Performance by President

     "It is better to be roughly right than precisely wrong."
- John Maynard Keynes

Fair or not, a president and his party are judged by the economic fortunes of the nation. It is widely accepted that the president is the navigator and pilot in directing the nation through economic waters. This was codified in the Full Employment Act of 1946. As we saw in the last chapter, Richard Nixon realized the political primacy of the appearance of prosperity after his loss to John Kennedy in 1960. When Nixon assumed the presidency eight years later he brought with him into the Oval Office what has come to be known as the "political business cycle." Candidates have made economic prescriptions the driving force of their campaigns ever since the 1920's and even before.. "Are you better off today than you were four years ago?" was Ronald Reagan's campaign mantra. "It's the economy, stupid," was Bill Clinton's ubiquitous reminder for staff.

Is there a difference between parties that can be quantified, an economic scorecard from which we can tabulate results and determine the winner? Or do the economic tides ebb and flow on an independent timetable, not influenced by policy any more than by banner and bluster? Yes, the data do present a definite verdict. Beginning in 1947 when reliable economic data came on line via the National Income and Product Accounts (NIPA), economic outcomes track the political affiliation of the president. One party has done better by virtually all measures of economic health.

It is not, to be clear, our contention that either Democrats or Republicans operate by a consistent game plan, nor that the economic results proceed directly from theories held by the presidents. The results are not accidents, but neither are they entirely planned. Results reflect, we believe, the constituencies served by policy more than they reflect theoretical intent. Constituency and theory meet in policy, and the policy of Democrats is fairly described as more Demand Side, while the policy of Republicans has been decidedly Supply Side.

Primary among criticisms of this approach may be three:

     (a)    The economy does not care who is in power. This opinion has been held by some influential professionals, including Nobel Prize winners, but is of little relevance politically or theoretically today. It is certainly not a belief promulgated in political campaigns.

    (b)    The influence of the president lags his term in office, and the results of his policies are credited to later presidents. While this is more plausible, it is still not politically or economically relevant. It is certainly absurd to assert - as have members of the radically conservative Heritage Foundation - that the economic initiatives of one president (Reagan) skipped George H.W. Bush and benefitted Bill Clinton, only to dissolve immediately as the latter left office.

    (c)    The president is only responsible for half the problem if Congress is in control of the opposition party. This makes some sense in the abstract, but less when confronted with the historical record, where the president's control of the executive apparatus of government and his leadership on policy have consistently outweighed contrarian Congresses. Instances where the nation has followed a strong economic policy distinct from that avowed by the president are nonexistent.

At a minimum it is fair to say that our results do not derive from designer statistics manufactured for the purpose of demonstrating a foregone conclusion. Growth, employment and profitability are described here in terms of the most widely used metrics - real GDP, the unemployment rate, and investment. We also offer some useful measures to give depth to the evidence: real GDP net of federal borrowing (which we term Net Real GDP), employment growth, and corporate profits as a percentage of total income.

In all categories the economy has performed better under Democratic presidents than under Republicans. Nearly every Democrat has outperformed all Republicans in all categories. Appendix B provides details of statistical sources and rankings, from which those in this chapter are drawn. A complete treatment can be found online at DemandSide.net.

Growth

The most commonly cited economic statistic is the growth of gross domestic product (GDP growth) or more often and more appropriately the inflation-adjusted measure real gross domestic product (Real GDP). GDP has some drawbacks. It is more a measure of activity than growth - the buzzing around the hive, rather than the size or strength of the hive, or even the well-being of the bees. These drawbacks and the need for more effective accounting, are discussed more completely in Part II. Still, as the most common statistic in the economic game, it is where we need to begin.

Real GDP has been stronger and steadier, and recessions (periods of negative growth) have been fewer, when a Democrat has occupied the White House. Even more stark is the difference using our secondary measure - Net Real GDP. This is simply Real GDP subtracting the federal deficit, including borrowing from the federal social entitlement funds. If deficit spending is pump priming, it is not appropriate to count the water used to prime as a product of the well. Net GDP corrects for this.

Democrats have been in the White House for 26 of the 60 years between 1946 and 2005. Real GDP growth has averaged 4.0 during that period. Republicans have been in power the other 34 years, during which time Real GDP growth has averaged 2.8 percent per year. Net GDP, taking into account the federal borrowing, drops Democratic performance to 3.5 percent. The same adjustment for Republicans drops their number to a meager 0.8 percent. More than two-thirds of Republican growth has been borrowed. Since 1980 there has been zero Net Real GDP growth under Republicans.

The difference of a point or two in growth may seem insignificant. But consider that an economy growing at 4.0 percent doubles in size every 13 years, and one growing at 2.8 percent, every 25 years. Growth of 3.5 percent would double an economy's size in 20 years. One growing at 0.8 percent would need 90 years to double in size. For Real GDP, the chart seems perhaps not to make the point asserted here. The bars seem to be of similar height, and only a couple of gaps distinguish the red from the blue. These gaps are telling, however. Democratic years are consistent.

Unemployment and Employment

In the realm of employment the most cited statistic is the rate of unemployment. Here we will use both that and a measure of growth in the workforce actually employed. Rates of unemployment or employment only partly describe the health of working America, however, since they omit wages and salaries, so we add some notes on income and wages. Unemployment has been lower on average under Democrats, 5.1 percent v. 6.2 percent. More striking than the actual rate is the progression of the measure over time.
Under Democrats unemployment has shown an unmistakable, persistent tendency to fall from year to year. After 1949 and the turbulence of transition from war to peace, only twice under Democrats has unemployment failed to fall. It rose once, modestly, under Kennedy in 1963, and then more substantially under Carter in 1980 in the context of the Iran oil embargo and the Volcker Monetarist experiment. We have used 2.0 as the baseline, although the minimum practical rate of unemployment is likely closer to 3.0 percent.

It is tempting to allow the charts to speak for themselves. Elaboration on the data may seem to be mere advocacy. The strength of the economy as measured by the employment of its members is described in the chart on employment growth. The stability of the blue bars as opposed to the volatility of those in red illustrates the success of millions of working people. Getting a job has often been characterized as a personal choice available to all the willing. If so, Democratic presidents have inspired many millions to be willing. Growth in employment has been strong and stable under Democrats. Not so under Republicans.

Weakness in employment numbers has historically, and not surprisingly, been reflected in wages and salaries. High unemployment means it is a buyer's market for labor. The experience of the American workforce in the years since 1980 compared with the period prior to that has been the difference between stagnation and opportunity.

In looking at the following statistics and relating them to our own bservations, we should keep in mind that an individual worker may do better over his or her lifetime as he or she advances in experience, skill, or seniority, but each group will not. For example, wages have declined for the 20- to 30-year-old unskilled labor force, yet of course, an individual will grow out of this category. The numbers show only that, as a whole, our economy is not progressing from the point of the majority of its citizens and that it is no longer true that children will do better than their parents did. That happy circumstance is a relic of the past.
Between 1947 and 1978, real hourly wages rose 72 percent. Weekly earnings, which factor in the number of hours worked per week, rose 53 percent. Between 1978 (the start of the Volcker Monetarist experiment) and 2006, real hourly wages fell 5 percent and weekly earnings fell 10 percent.

Median income of all Americans rose 107% between 1947 and 1978, a number greater than the earnings figure partly reflecting the increase in the proportion of Americans employed and partly reflecting investment and interest income. Between 1979 and 2005, median income rose only 9 percent.

Manufacturing employment peaked in 1979, with 19.4 million (one in five workers) engaged in the manufacture of durable or nondurable goods. In 2006, only 14.2 million were so employed (one in ten).

Investment and Profitability

To judge economic performance from the perspective of business and investors, we turn to some lesser known statistics: gross private domestic investment and corporate profits as a percentage of total national income.

Investment

Gross private domestic investment is the most notable and most often referenced measure of investment in the National Income and Product Accounts (NIPA). It is comprised of (1) business investment in plant and equipment, (2) residential construction and (3) investment. The most important exclusion is government investment, which is treated simply government expenditure.    It is very important to most treatments of the multiplier which treat investment as exogenous (coming from outside the system).
Here, however, we attempt to connect the lines between investment, profitability, employment and effective demand. So the only truly exogenous investment arises from government, whose concerns may exist outside the economic sphere.

Volatility appears in both blue and red in gross private domestic investment. The Truman years were wildly up and down in this category, as the demand and supply of consumer goods, industrial capacity, and housing after the war sorted itself out. The disruption of the Korean War further roiled the water. The tremendous spike in Reagan's first term is due in large part to Supply Side tax policy details which actually made some investments cost less than nothing. The modest rise of investment in the 2000's can be attributed in part to the run-up in residential housing. It remains to be seen how passive housing investment translates into economy-wide strength or weakness.

Total private domestic investment grew at an average annual rate of 6.6 percent through the years of Democratic chief executives. Under Republicans, the figure was less than half that, 3.2 percent (through 2004).

Profitability

Our statistic for corporate profitability is not the gross dollars of profit, and not even dollars adjusted for inflation, but profits as a percentage of total national income. This might raise some antennae sensitive to "designer" statistics. Our measure is not created to hide the gross profits or growth in profits, however, which becomes obvious when we realize the percentage figure implies a larger piece of what is revealed in the previous GDP statistics as a larger pie.   The percentage thus cannot hide a gross figure if it favors Democrats because the product of the two must favor Democrats. The point of our "piece of the pie" statistic is to show that investment is sensitive to profitability.

The proportion of total income that found its way into corporate profits was 11.4 percent under Democrats and 9.9 percent under Republicans. Corporate profits are not as unambiguous as might be at first imagined. Profits are revenues in excess of costs, and a company which perceive the potential for greater profits in the future might be willing to forego present gains to invest. The reverse might also be true. If long-term prospects did not seem promising, a company might reduce investment in the short term, cutting costs and increasing the gap between revenues and costs, which is profit. Countering these, as discussed in Chapter 5, is the tremendous incentive for corporate managers to magnify current profits, since they often translate to stock prices, and stock prices directly influence managers' compensation. All of which cautions us that present year profits are not necessarily related to the health or prospects of a company. Still, however ambiguous, the relationship is there.

As we pointed out in Chapter 3's look at the Reagan years, the Supply Side construction that investment relates to costs of inputs, taxes, or savings rates does not find verification in experience. By contrast, Demand Side strengths - employment and income (as described by GDP) - do follow with investment and profitability.

A last note. The deficits and their costs are connected to these factors in several ways, among them through the price of money - interest. This affects both the cost of investment and the strength of demand. The high deficits illustrated in the Chapter 3 discussion of the Reagan years and in the Net GDP discussion earlier here in Chapter 4 follow right along with lower profits, lower GDP and lower employment. The contrary Supply Side notion that investment can be coaxed by favorable regulations or tax treatment leads to policies which are dangerous disruptions to the market. And that notion is in any event belied by the evidence.

2009-08-01T09:51:00.000-07:00

Chapter 14:

Demand Side Tools, Forecasts

The Multiplier

bold is in chapter 2

In concert with its originator R.F. Kahn, Keynes also developed and promoted the multiplier. Investment or government expenditure creates an economic surge as it echoes through the economy. The producer of one good is the consumer of another as his good is sold and he spends his income. Thus, money can be followed from hand to hand as it facilitates the exchange of goods and services. The same money buys shoes from the shoemaker as buys bread from the baker as buys meat from the butcher, but the consumer changes from shoemaker to baker to butcher. If the money stops - as above - in one or another's cookie jar, the sequence of purchases and sales is interrupted and the employment of people and facilities down the line never occurs. The economic activity is stopped by the act of hoarding.

The corollary to this sequence is Kahn's multiplier. Any particular amount of government spending or private investment will create multiples of that amount in economic activity, as the first new income is passed from consumer to producer, who then becomes the next consumer. The multiplier describes how much more activity will be created. It is the multiple of investment or government deficit spending in real increased economic activity.

Different economic actors will affect the multiplier differently. As the money passes through a poor person, for example, it will likely survive intact as a purchase of a good or service because a poor person tends to spend all of his or her income. Similarly, payments that go through government accounts tend to employ people and survive as demand for the subsequent services, because government is not in the business of saving. In contrast, payments to the wealthy are not so readily turned over. The tendency to save or spend in a manner which is tangential to the main economic life of the society is much greater among the wealthy. A full exploration of the multiplier and the factors that act to reduce it is presented in a later chapter.

Today the multiplier survives primarily to describe the stimulus value of government deficits and to offer an inappropriate justification for all tax cuts. Keynes himself preferred direct employment through public works.

As all reliable economics texts will attest, direct government spending is undoubtedly greater stimulus than tax cuts, since the first round of leakage from private spending is absent in government spending. Tax cuts balanced by spending reductions are undoubtedly contractionary, for the same reason. Tax cuts funded by deficits is absurd economically, as it means revenue formerly generated in taxes is now being borrowed. Yet this is precisely the policy of the current Bush administration. The same revenue thus comes with the cost of interest attached.

Tax cuts also produce on the margin of personal demand. The "margin" refers to the last increment. Marginal income tax rates, for example, refer to income above a certain level. Income below that level is taxed at a lower rate. In the case of tax cuts, the money freed up to individuals and households would be spent on items less essential than the first dollars of income. Thus tax cuts produce more discretionary goods and services than direct employment from public works - more deodorant and cell phones and fewer houses. Public works employ people directly and distribute demand across the full spectrum of household needs.

The liquidity trap

Examples of those public goods:

2009-07-29T10:20:00.000-07:00

Chapter 15:

Structuring the Market

2009-07-16T10:24:00.000-07:00

Chapter 16:

Productivity Explained - The Rule of 8

2009-07-15T10:26:00.000-07:00

Chapter 17:

Investment Explained - The Rule 0f 70

BOLD INCLUDED IN CHAPTER 11

Investment

Demand Side as expressed here profoundly diverges from Classical or Conservative economics on the issue of investment. Investment in productive forward-looking capital is vital. Investment in the public's infrastructure and human capital accounts have to be included along with private capital investment. Currently they are ignored in any effective form. Public investment in roads and infrastructure and so-called "human capital" - education and social services - can be best understood in the terms used in the previous discussion of Public Goods. The challenges of the future will require more Public Goods, but since the market cannot effectively produce Public Goods, the mechanism of demand will need to be collected under a public agency.

The following discussion leaves some of these issues for another debate another day and refers to investment in conventional terms of private investment in plant and equipment and housing. Understanding private investment from the Demand Side exposes the shaky underpinnings of Classical Supply Side.

Under Supply Side private investment has been the raison d'etre for virtually all economic development schemes for the past century. Attracting such investment and the attendant (often ephemeral) high-paying jobs has excused many fiscal extravagances and has engendered a fierce competition between states and nations.

Supply Side and Classical economists assume that private investment is a function of the savings rate. This is a misreading of an algebraic identity which simplifies into Savings = Investment. From this equation and the fact that it reflects, that investment is financed by savings, it assumed that savings produces or causes investment, that the causal arrow runs from savings to investment. This sparks much excitement from bankers and amateur economists about encouraging savings and raising the savings rate and so on.

Two test cases ought to give us pause. One is the Great Depression, where saving (or hoarding) was seen to be a cause for economic stagnation, since spending produces income and income produces spending. The other case is that of modern Japan, which had an enormous savings rate of 14 percent of household income at the start of the 1990s and a national savings rate (includes corporate savings and government deficits) of 25% in 2005 (FN: but which has been mired in stagnation for two decades.

The causal arrow, in fact, runs in the opposite direction, from investment to savings. This will perhaps be easier for the lay reader than for the expert to understand. Ask the question, "What causes an individual investor or entrepreneur to invest?" The answer is, of course, "The prospect of making a profit." The investor sees a need or unmet demand and moves to fill it. He then goes and finds the capital. If the financing is too dear, it may scuttle the project, no doubt. But much more often the prospect of profit brings forth financing. That is, it is the strength and nature of demand that elicits investment.

This is empirically verifiable. In times of strong demand investment has flourished, the stock of plant and equipment has increased, and financing has been available. We will see that in Chapter 4, which displays economic performance under different presidents. The coincidence of high GDP growth, high employment and strong investment is marked. Which is the cause? They go hand in hand. The contrast again is Japan with its enormous savings rate and its low economic performance.

How is it, then, that savings and investment equate? The example of a hot air balloon may be helpful. A balloon rises to the point at which the pressure inside is roughly equivalent to the pressure outside. Does the pressure outside cause the pressure inside? No. They equate. The balloon has risen to the altitude where they equate. It is the altitude that is the dynamic factor. This altitude is the income level. The savings rate and the investment rate both depend on income. The higher the income, the higher both savings and investment. From this we can predict that strong demand for new energy and transportation technology will only improve investment, income and savings.

Again, the lay observer will have less difficulty with the concept that strong demand elicits more investment than slack demand. It may even seem natural. The Supply Side bias that prefers tax breaks for the wealthy and investment incentives to corporate producers has not worked because it cannot work. This is pushing on a string. As the historical record of the Reagan administration shows, the Supply Side incentives are routinely pocketed and produce no net new investment.
Savings and investment.

Savings will be drawn down in a recession. People have to live.

From the Prudent Bear, October 26, 2009

Where have all the savers gone?

    * by Martin Hutchinson
    * October 26, 2009

In the recent unpleasantness, the United States made some progress towards solving its biggest economic problem of recent years: the lack of U.S. savings. Regrettably, in the latest figures, the beginnings of economic recovery have brought backsliding, with the savings rate dropping back from 6% to 4.3%. Without more savings, as global liquidity declines, the United States will quickly become a capital-starved economy, losing investment to capital surplus countries where savings are plentiful. The difficult questions are: what caused the savings decline, and what can be done to reverse it?

During the halcyon years of the 1950s and 1960s, the U.S. savings rate – the percentage of disposable personal income that is saved – was consistently over 10%. That is nowhere near as high as the 40% savings rates consistently seen in China (though questions remain over the quality of Chinese statistics), nor the 25% to 30% of the other major East Asian economies during their takeoff phases. The United States was always a culture not particularly given to saving, and 10% is not a brilliant savings rate – it is for example lower than Germany's level even in today's culture, of a solid 11% – but it was sufficient to allow the great economic growth of the 1950s and 1960s to be financed domestically.

The U.S. savings rate began to decline during the 1970s. That was not surprising; during that decade the stock market went nowhere (declining heavily in real terms) while interest rates were steadily negative in real terms, even lower when you take account of the fact that savers had to pay tax on gains and interest income that was eaten away by inflation.

After the 1970s, one would have expected the savings rate to rebound. Real interest rates were very high in the 1980s, inflation came down from 1982, and the stock market embarked on a generation-long bull market that was to raise the Dow Jones Industrial Average to 10 times its 1982 level. Yet instead of rising, the savings rate fell. From an average level of 10.8% in the 1960s and 8.6% in the 1970s, the savings rate declined to an average of 5.8% in the 1980s. The deep 1981-82 reduced it, as one would have expected (the savings rate went negative during the worst years of the Great Depression), but it never recovered thereafter.

The savings rate declined somewhat further, to 4.9%, during the 1990s; again it dipped during the early 1990s recession, then recovered in that later 1990s, when real interest rates were low but stock market investment was uniquely appealing.

Then from a peak of 6% to 7% in 2000, the savings rate declined to depths not plumbed since the bottom of the Great Depression, reaching 1.8% in 2003, near the bottom of that relatively mild recession, then failing to recover significantly, before plunging again in 2007-08 to a level currently assessed at exactly zero.

There appear at first glance to be three factors that may have affected the trend in savings rates:

The first and most important is the return available to saving. If as at present or in the 1970s, deposits and fixed-income investments provide savers with a return that is less than the rate of inflation, then savings rates are bound to decline. People won't save because they are being penalized for doing so. This is why the expansive monetary policies favored by Greenspan, Bernanke and others are so misguided. A capitalist economy cannot survive if its risk-free rate of return is below or close to zero for prolonged periods, because people will have no incentive to defer consumption and so capital will disappear. You only have to look at the unhappy fate suffered by the German Weimar Republic and various Latin American countries in bouts of hyperinflation to see the result of de-capitalizing the economy in this way.

Argentina is no longer a rich country for this reason. Its people are perfectly industrious and 97.2% are literate, its education system is adequate, its natural resources are abundant, its climate is healthy, yet through bouts of hyperinflation, its governments have de-capitalized its economy. Without a recovery in the savings rate, the United States is heading down the Argentine route to perdition.

The second reason why the savings rate may have declined is the revolution in consumer finance since the 1960s. This supposition is reinforced by the higher savings rate in Germany, a country with a more generous pensions and healthcare safety net than the United States (which should depress private savings), but with less overwhelmingly available consumer finance. This factor may explain a large part of the savings rate's 1980s' decline. The first unsolicited credit card offers were sent out by Citigroup in 1978, and by the middle 1980s, cards were proliferating and it was perfectly possible to carry several of them. Total consumer debt outstanding remained constant as a percentage of Gross Domestic Product (GDP) in the 1970s, falling from 12.5% of GDP to 12.4%; it then took off around 1980, rising to 13.8% of GDP in 1990, 16.3% of GDP in 2000 and 17.7% of GDP by its 2008 peak. Thus from 1980 to 2008, consumer debt rose annually by an average of 0.19% of GDP (in addition to its natural rise from economic growth) – about 0.3% of personal consumption. That's a significant albeit modest contribution to the savings rate's decline.

The third reason, impossible to quantify, is the attitude to saving of the U.S. population itself. The generation who were adults in the 1950s and 1960s had experienced the Great Depression. That did not simply make them cautious; it also gave them a high regard for the value of substantial savings – which had after all increased in real value by 25% in the first years of the Depression. Conversely, the baby boomers and their successors, the adults of the 1980s or today, have not experienced real financial hardship and, in the 1970s, saw inflation eat away inexorably at the value of savings. One need not grind one's teeth at the moral inferiority of the baby boomers to realize that their different life histories might reasonably have given them different attitudes to saving. The same effect seems to have occurred in Japan, where savings rates dropped from 25-30% in the 1970s to around 5% today; the stock market slump and economic stagnation are unlikely to provide a sufficient explanation for this change.

To restore the U.S. savings rate, we thus need three things: higher savings rates (painful, but easy, and necessary in other respects), tighter consumer finance availability (tricky), and reversion to the pro-savings attitudes of the 1950s and 1960s (very difficult.) Nevertheless, the goal is sufficiently worthwhile to the long-term future of the U.S. economy that a number of policies leading in its direction might be tried, as follows:

    * Prolonged period of interest rates at least 3% above inflation, together with tax changes allowing the elimination of inflationary erosion of capital from investment income.
    * Elimination of tax-deductibility of mortgage and other interest, and of all government subsidies to home ownership, including in particular Fannie Mae and Freddie Mac guarantee programs. In today's private market, 20% downpayments for home mortgages would be required by banks forced to hold mortgages themselves. This would force massive saving.
    * Rapid elimination of federal deficit, reducing government's contribution to national de-capitalization.
    * "Tobin tax" on securities transactions, primarily affecting Wall Street trading operations, but also removing the percentage of national wealth acquired through short-term speculation.
    * Heavy excise on casinos, hotels and transportation to casino destinations, and abolition of state lotteries, reducing the gambling propensities in U.S. society. "Get rich quick" methodologies of all kinds must be discouraged.
    * Full funding by government of the requirement that indigent patients receive treatment in hospital emergency rooms. Also tight limits on medial liability damages and removal of restrictions on inter-state purchase of health care. Apart from making medical care affordable, this would reduce the truly exorbitant charges by urban hospitals, eliminating much of the medical bankruptcy risk and making savings more attractive through reducing the risk of some leech hospital seizing them.
    * Elimination or drastic reduction of the "death tax" to encourage capital accumulations in families.
    * Elimination of the double taxation of corporate dividends, by making them deductible at the corporate level (while fully taxable at the individual level.)
    * Prohibitions against unsolicited mass credit card mailings and their e-commerce equivalents.
    * If necessary, a credit tax on all purchases not paid for in cash or by debit card or check. This would have the effect of a limited value-added-tax, but applied to credit transactions only.

As you can see, there are innumerable unpopular but fairly easy steps that could be taken towards raising the savings rate. We can't recreate the psychology of the 1950s, but these changes taken as a whole would push society in that direction.

If the alternative is an Argentine future, the pain would be worth it.

The Bears Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long '90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.

Martin Hutchinson is the author of "Great Conservatives" (Academica Press, 2005). Details can be found on the Web site www.greatconservatives.com

2009-07-13T10:26:00.000-07:00

Chapter 18:

Growth Explained - Incentives Matter, to Everybody

2009-07-13T04:00:00.000-07:00

Chapter 19: Inflation and Deflation

Cost Push vs. Demand Pull

Fed adds to inflation when it thinks it is subtracting because higher interest costs are passed through.

Absence of inflation in the early 2000s with the heavy investment in housing was not a Great Moderation (Bernanke), but evidence of disinflationary pressure.

Asset price inflation is a bubble.

Prices rise in booms, according to Minsky, to incorporate the profits.

There are two kinds of producers, price-takers and price-makers

Deflation or inflation may occur in sections of the economy.

Here from the Atlanta Fed a description of prices September 2009

The September CPI with all the trimmings
from macroblog by David Altig

Yesterday, the U.S. Bureau of Labor Statistics reported that retail prices rose 2 percent (annualized) in September, and it characterized the increase as "broad based, although tempered by a decline in the food index." Indeed, the traditional measure of core inflation (the consumer price index, or CPI, less food and energy) also rose 2 percent (annualized) in September.

But if you read just a few sentences further into the report, you get this observation:

"Contributing to this increase were advances in the indexes for lodging away from home, medical care, new vehicles, used cars and trucks, and public transportation. The increase occurred despite declines in the indexes for rent and owners' equivalent rent, the first decreases in those indexes since 1992. The energy index also increased in September, as increases in the indexes for gasoline, fuel oil and electricity more than offset a decline in the index for natural gas."

This observation begs an important question: What exactly does "broad based" mean here? Rent and owners' equivalent rent actually declined last month. These categories represent a shade more than 30 percent of the CPI. If you add in all the other things that showed outright price declines in September, like food, car rentals, men's apparel, and furniture, about 44 percent of the CPI fell last month. In fact, the two of us believe there is ample evidence in the data of significant disinflationary pressure—much more than the CPI or the core CPI would imply.

One way to get a sense of how broadly based the September price increases are is to examine the "trimmed-mean" estimators produced by the Federal Reserve Bank of Cleveland. Trimmed-means compute the rise in the CPI after excluding, or trimming, a proportion of the most extreme price movements. (If you want to learn more about this procedure, we suggest you read here or watch the Cleveland Fed's "Drawing Board" segment on the idea.)

The figure below shows all of the trimmed-mean CPI estimators ranging from just a tiny proportion of the items trimmed to virtually all of the items trimmed.

For the September CPI, note the rather dramatic drop in the estimate of retail inflation as you trim only a small share of the extreme price changes in the CPI market basket. Just cutting out the most extreme 6 percent of the highest and 6 percent of the lowest price changes reduces the measured inflation rate from 2 percent to 1.5 percent. And the more you trim, the lower the inflation estimate. The median CPI rose a mere 0.5 percent last month.

An interpretation of these data is that the September CPI increase was anything but broad-based. Moreover, the data seem consistent with the idea that prices overall are on a path of disinflation. During the first four months of 2009, the majority of the trimmed-mean estimators put retail inflation roughly between 2 percent and 2.3 percent. In the May to August period, most of the estimators were under 1.3 percent. In September, the majority were under 1 percent.

By Michael Bryan, a vice president in research at the Atlanta Fed, and Brent Meyer, an economic analyst at the Cleveland Fed

2009-07-12T10:27:00.000-07:00

Chapter 20:

Stimulus and Budget

2009-07-12T04:33:00.000-07:00

Chapter 21 Monetary Policy

The consensus view holds that the unprecedented – and ongoing – intervention is fundamental to crisis resolution and sustainable recovery. Noland counters here that such massive market intrusions always create the backdrop for excesses and the next crisis. The Fed is fighting the last war. Instability still looms, as well as orthodox myopia.

Mortgage Madness:
by Doug Noland
Prudent Bear
October 24

October 22 – MarketNews International (Steven K. Beckner): “Federal Reserve Vice Chairman Donald Kohn said Thursday that prices of mortgage-backed securities are likely to fall when the Fed eventually begins selling MBS from its portfolio. He gave no indication when that might be. But Kohn, echoing earlier comments by New York Federal Reserve Bank President William Dudley, said the Fed may well avoid any losses on its asset holdings, as well as on its liquidity facilities. ‘These programs may be unwound without loss,’ Kohn said, commenting from the audience at a Boston Federal Reserve Bank conference. He said the Fed entered the market ‘when prices were depressed by high premiums’ and so ‘the Fed could finance without risk.’ That in turn will mean they can be ‘unwound without loss.’”

Federal Reserve holdings of mortgage-backed securities (MBS) this week exceeded those of Treasuries for the first time ($777bn vs. $774bn). The Fed is now well past half way through its program to purchase $1.25 TN of MBS – which is slated to be completed in March. Federal Reserve Credit jumped to $2.172 TN, up from less than $900bn to begin September 2008.

Mr. Kohn is too optimistic. My view is that the Fed is paying too dearly for these mortgage securities and large losses are inevitable. And while Fed-induced price distortions are not having a big impact on U.S. housing, they exert enormous influence on finance and markets globally. I don’t expect the Federal Reserve’s MBS portfolio to be unwound anytime soon. Instead, the Fed will live with this exposure for years to come – and will likely expand the scope of mortgage exposure in future crisis periods. And I expect Washington’s conglomeration of mortgage risk will at some point make or break the dollar.

In the five years preceding the Lehman collapse, benchmark Fannie Mae MBS yields averaged 5.60%. A very strong case can be made that Fannie, Freddie and the entire mortgage Bubble pushed mortgage borrowing costs artificially low. Over the past year, as the Fed has been building its Trillion dollar MBS holding, benchmark yields averaged 4.30%. Fed officials have been talking confidently of their success in unwinding various liquidity facilities that were implemented during the crisis. Yet the most meaningful government intervention runs unabated throughout the mortgage marketplace. Between the Fed, Fannie, Freddie, Ginnie Mae, and the FHA – it’s full speed ahead into the uncharted waters of mortgage market nationalization. It is not easy to envisage a viable exit strategy. Few contemplate the costs.

The consensus view holds that this unprecedented – and ongoing – intervention is fundamental to crisis resolution and sustainable recovery. I counter that such massive market intrusions always create the backdrop for excesses and the next crisis. Most believe inflation does not these days pose a risk and that loose monetary policies no longer foster financial leveraging and other dangerous excess. Indeed, most see this as an atypical backdrop with little risk to fiscal and monetary looseness. Many argue that sticking with unprecedented policy responses for an extended period is the appropriate course to combat deflation. I contend that each government-induced reflationary period comes with its own set of inflationary biases, market responses, excesses, and risks. But they’re not going to jump up and down and make themselves obvious.

Yet some aspects of policy risk are becoming more apparent. This week, China reported 8.9% third quarter GDP growth. The Chinese economy has bounced back convincingly, and Bubble dynamics have returned in full force. Increasingly, there is a case for a surprisingly strong recovery throughout Asia and the emerging markets. Crude oil this week traded to $82. The Goldman Sachs Commodities index jumped 2.2%, increasing y-t-d gains to 48.8%. Global reflation has attained a head of steam - and the Bernanke Fed is falling only further behind the curve.

Of course, the counter-argument is that U.S. unemployment is 9.7% and the recovery is fragile. The Fed’s dual mandate – price stability and full employment – certainly provides good cover for sticking with ultra-loose monetary policy. Besides, few see meaningful risk inherent with Fed policymaking anyway. Nonetheless, the bottom line remains that U.S. monetary policy and the weak dollar are the dominant forces powering inflationary forces globally.

It is a fundamental tenet to my thesis that the unfolding reflation will be altogether different than previous reflations. The old were primarily driven by Fed-induced expansions of U.S. mortgage finance and Wall Street Credit. Our mortgage industry, housing and securitization markets, and Bubble economy were at the epicenter of global reflationary dynamics. The new reflation is fueled by synchronized fiscal and monetary stimulus across the globe. China, Asia and the emerging markets/economies have supplanted the U.S. at the epicenter. U.S. housing is completely out of the mix.

Those fixated on old reflationary dynamics look today at tepid U.S. housing markets, mortgage loan growth, consumer spending, and employment trends and see ongoing deflationary pressures. The Fed is wedded to the old and is positioned poorly to respond to new reflationary dynamics. A stable dollar used to work to restrain global finance – hence global inflationary forces. The breakdown in the dollar’s stabilizing role has unleashed altered inflationary dynamics – forces that the Federal Reserve disregards.

Two open questions come to mind. First, when will the new global reflationary dynamics meaningfully impact the U.S. inflation outlook? Second, what impact will the prospect of foreign central bank tightenings have on U.S. market yields?

U.S. market yields are not priced for a global reflationary backdrop. Notions of a “new normal” and a central bank content with an extended hiatus tug U.S. and global yields artificially down. Fragile U.S. underpinnings have global markets convinced both that the Fed will err on the side of ultra-loose monetary policy and that dollar weakness will constrain global policy tightening. The brunt of global reflationary forces may have shifted overseas, but the U.S. remains firmly at the epicenter of market distortions.

And nowhere do price distortions have more impact than in the mortgage arena. While Washington and the media focus on Wall Street compensation and regulatory reform, an incredible amount of mortgage risk quietly shifts to the American taxpayer. Beyond the Fed’s $1.25 TN of MBS, Fannie’s and Freddie’s “books of business” continue to expand, while the FHA and Ginnie Mae balloon their exposure to risky mortgages. In the short-run, this process reduces systemic stress and boosts market liquidity. The markets remain quite happy with this dynamic – for now.

The secular bear thesis and the next round of financial crisis don’t require a wild imagination: The U.S. economy underperforms in the new global reflationary backdrop. The Fed stays ultra-loose for too long – along with timid Chinese and other central bankers around the globe. The U.S. fixed income marketplace – especially MBS – becomes too predisposed to artificially low Fed funds and market yields. Historically low U.S. yields – in the face of booming Asia/emerging markets – continue to weigh on the dollar. Dollar devaluation and global dynamics set the stage for an inflationary surprise. And any jump in inflation fears would find U.S. bond and mortgage markets especially poorly positioned, with the U.S. economy extraordinarily vulnerable to any spike in yields. A crisis in a rising rate environment would be especially problematic for a Fed and Treasury confronting Trillions in mortgage Credit and interest-rate risk. Foreign holders of our mortgage paper could lose big if market prices and the dollar move against them simultaneously. And it’s safe to say that the Federal Reserve wouldn’t be profitably unwinding its MBS portfolio.

2009-07-11T10:29:00.000-07:00

Chapter 22:

Trade, the Bankruptcy of Comparative Advantage

2009-07-09T10:32:00.000-07:00

Chapter 23:

American Agriculture - Starving the World

2009-07-07T10:31:00.000-07:00

Chapter 24:

The Economic Imperative of Climate Change